Albert Einstein is believed to have said that compound interest is one of the most powerful forces on earth, and we think he’s right.
Compound interest allows your money to continue growing faster and faster and faster the longer you have it invested because the interest you earn is rolled back into your principal so it can start earning interest as well.
To understand why compound interest is so great, you have to see it side by side with simple interest. We could sit here and try to explain the concept with words, but the numbers really do all of the talking.
In this example, we are using a starting principal balance of $10,000 and a 10 percent interest rate. With simple interest, the principal balance remains the same throughout, but with compound interest, the interest payment is rolled into the principal each year.
As you can see, at the end of 10 years, you receive more than 50 percent more money in interest payments with compound interest ($15,939) than you do with simple interest ($10,000).
The Time Value of Money
The longer you are able to invest it, the more valuable $1 today becomes. That is the concept of the time value of money in a nutshell.
It makes sense. The longer you can let your money grow and compound, the more money you will have in the end. However, most people don’t understand the true power behind the time value of money. Too many people believe that if they leave their money in their investments for twice as long, they will end up with twice as much money. They are wrong. They forget about compound interest.
Hopefully the example below will help illustrate the concept. In this example, we are using a starting principal balance of $10,000 and a 10 percent interest rate. In one column, we will leave the money invested for 10 years, and in the other column, we will leave the money invested for 15 years.
You can see that by leaving your money invested for 15 years—only 5 years longer—you would have more than doubled ($31,773) the interest payments you would have received on your money if you had only invested it for 10 years ($15,939).