A Quiet Fortune: The most powerful force in the universe
I’d like to talk with you about a unique phenomenon: compound interest. Albert Einstein is credited for calling compound interest “the most powerful force in the universe.” Whether he actually said those words or not has been challenged, but Einstein was more than impressed with its potential. We should be too.
So what is compound interest? It’s the money we make when we invest money, and then keep investing both the original amount (the principal) and the interest we will earn.
Here’s a basic example, using an admittedly generous return of 10 percent:
During the first year of an investment of $100 we would make $10 in interest if we put our money into something that returns 10 percent. The compounding part comes the next year when the amount we invest is now $110. That second year we will make:
$110 x .10 (10%) = $11
Look at that: $11! We’ll make one dollar more on 100 than we did the first year because:
• We have once again made $10 on our original investment, but now:
• Because we kept our interest in the account and earned interest on that interest, we have also made an extra dollar.
Our interest has compounded.
You may be thinking, “Big deal: a whole dollar more. Do you seriously think it’s time to celebrate?”
Actually, it is a big deal. Certainly not this year, or the next. But imagine that our single deposit of $100 grew at 10 percent every year for a long time. If we were very young when we first put that $100 in an investment returning 10 percent, say 10 years old, we’d have made an additional $11,639.09 from our 100 by the time we turn 60.
Now that’s a big deal.
What if a 20-year-old put $100 a month into an account and did so for 40 years? At 8 percent interest, the total will be $351,500. A 9 percent return will become $471,700. Ten percent will bring that total to $637,770. More years or larger amounts invested become even more interesting.
There has to be a catch, right?
Actually, there are two.
The first is the way I’m using the word “interest.” That word actually means guaranteed investments that pay you for lending your money to some entity like a bank. We earn guaranteed interest with things like certificates of deposit and savings accounts. But in today’s world that kind of investment will not earn anywhere near enough to make a difference for the future. We can use the basic idea, though, in investments that are not guaranteed but that have shown good growth for a long time despite the ups and downs that will inevitably occur.
The second problem seems to be that many people don’t catch on to the idea of how money can grow exponentially. We may learn something about it in school but we often don’t put it into practice for our own benefit.
The essential piece is Time. With a capital “T.”
It’s hard to make compounding work easily for us when we get older. We simply don’t have enough time. We can’t invest just a little bit of money, yet end up financially secure, if we are in our 40s or 50s before we start to think seriously about our futures. By that age we have to go to Plan B or C.
But this concept, Plan A, is surprisingly effective for young people. They do have Time. Parents and grandparents can help them to start a future that will be filled with security just by talking about compounding once in awhile and encouraging the idea of saving.
Einstein was right about that “most powerful force” thing: Let’s pass it on.
Want to design your own scenarios? Search “compound interest calculators” on the web.
Terrie Drake is the author of the book “A Quiet Fortune,” and a retired teacher and librarian. She and her husband have lived in Glenwood Springs since 1974. She is not a financial adviser; consult a competent professional for your personal financial solutions. She can be reached at firstname.lastname@example.org.