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Compound Interest Can Help Make You Rich

Don’t miss out on one of the most powerful tools you have at your fingertips.

Articles by Bobby Glotfelty
By Bobby Glotfelty Senior Licensed Financial Professional, Betterment Published May. 27, 2020
Published May. 27, 2020
4 min read

If you’re young, you’ve got a secret weapon. A huge secret weapon. Think on the scale of the Kryptonite that’s designed to bring down Superman. We’re talking about compound interest, and yes, compound interest is that powerful.

Even Albert Einstein said that  “Compound interest is the eighth wonder of the world.” And we all know he was a smart guy.

What is compound interest?

Interest is money earned on money you saved (lent) or invested.

Compound interest refers to both the interest you earn on the money you’ve saved or invested, but also the interest you’ve earned on your interest. It’s your money making more money. It’s one of the best ways for you to put your money to work over time.

If you let your money sit in cash under your mattress, your money can’t earn more money through compound interest. The sooner you put your money to work by investing it, the more you can expect to have later down the road.

While there are other ways to put your money to work for you, we’re talking about compound interest in reference to investing, because investing is the one of the most powerful things you can do to build wealth for the long-term. Keeping your money in a high-yield cash account, like Cash Reserve, can make sense for the short-term financial goals you have. However, if you have a long-term financial goal, like retirement, then investing your cash is usually the way to go.

Here’s how compound interest works to make you richer.

Let’s say you’re 18 and you plan to retire when you’re 65. This means that you have 47 years to save and invest. If you put $100 a month under your mattress for 47 years, you’ll have saved $56,500.

If you save the same amount but have an average annual return of 7%, compounded daily, you’d end up with $445,559 after 47 years. That’s over a $389,000 difference, even though you still only saved $100 a month.

The graph below shows that if you invest for your long-term goals, compound interest can grow your portfolio much quicker than if you were to just save cash over time.

Exponential Growth of Compound Interest Over Time

Graph showing increased value over time because of compound interest

Source: Investor.gov calculator. Assumes an initial investment of $100, monthly contributions of $100, for 47 years, with an annual interest rate of 7%, and daily compounding. Hypothetical examples are for illustrative purposes only. All events, persons and results described herein are entirely fictitious and amounts will vary depending on your unique circumstances and factors not necessarily accounted for here, such as market volatility, inflation, advisory fees, reinvestment of dividends or earnings, etc.

Time is compound interest’s best friend.

Time is the biggest key to compound interest. The more time you have to save and invest, the more money you can expect to make on your money. Your money can grow exponentially.

Young people have a huge advantage because time is on their side. This is why you’ll frequently hear financial advisors say that “The best time to start investing is now.”

The interest you’ll earn initially is relatively small, but as time goes on, it becomes much bigger. The largest increases in value usually take place in the later years—that’s why patience is important when investing. In the above example, over 33% of the added value takes place in the last 5 of the 47 years.

You know Warren Buffett, one of the richest guys in the world? The vast majority of his net wealth has come in the very latest years of his life. It took him roughly 56 years to build a net worth of $1 billion. It took him only 27 years after that to turn that $1 billion into nearly $60 billion—and for that, he largely has compound interest to thank.

Going back to our example, the graph below demonstrates how much value compound interest can add every year. You can see that the added value increases as the years increase.

Added Value of Compound Interest Over Time

Graph showing added value of compound interest over time

Source: Investor.gov calculator. Assumes an initial investment of $100, monthly contributions of $100, for 47 years, with an annual interest rate of 7%, and daily compounding. Hypothetical examples are for illustrative purposes only. All events, persons and results described herein are entirely fictitious and amounts will vary depending on your unique circumstances and factors not necessarily accounted for here, such as market volatility, inflation, advisory fees, reinvestment of dividends or earnings, etc.

If you’d like to play out other scenarios on your own, check out the SEC’s compound interest calculator.

Yesterday Is Gone—All You Have Now Is…Now

The sooner you start putting your money to work, the more time you have for compound interest to work in your favor. No matter your age, you can start making your money work for you and see the eighth wonder of the world for yourself.

Start compounding

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