The Power of Compound Interest
Compound interest is one of the most powerful forces in the universe. In 1803, the U.S. paid France $15 million for the Louisiana Territory (828,000 square miles). This works out to a price of about 3 cents/acre. What a deal for the U.S., right?! However, let’s imagine for a moment that France had the opportunity to invest that money and earn 9.25% per year. Any idea much that money would be worth today? $3,262,458,255,985,651.92! I had to look up what to even call this number it’s so big – over 3 quadrillion dollars!
Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.
Albert Einstein (maybe)
Compound Interest – What Is It?
When you invest money, you usually get a % return. For example, if you invest $100 and the return is 10% per year, it means after 1 year you’d have $110. Nice, but not a huge deal, right? Well, the second year, you’re not only earning interest on the $100 you started with, you’re also earning interest on the $10 extra you earned too. $110 x 10% = $11 earned this year. Now you have $121. The next year, 10% of that is $12.10, and so on. It grows very slowly at first. But given enough time, it can lead to gigantic sums of money. Use the calculator below to see how much your money can grow with enough time and interest.
How Much Do I Need to Invest Each Month to Become a Millionaire?
If you have time on your side and are getting a good return on your investments, probably a lot less than you think. Check out the charts below to see how much you need to invest each month, depending on when you start and your rate of return, to become a millionaire before you turn 66.
How A Teenager Can “Earn” Over $50/hour
When I was 15, I was getting paid $10/hour to mow lawns. At that age, $10/hour was great money for a kid, but seemed like nothing compared to what some adults were making. It would take me a whole day of mowing lawns to earn what my parents could make in just 2-3 hours. However, I had time on my side! If instead of spending that $10/hour on candy at the corner store, I invested it and earned 7%, 26 years later, when I was my parents’ age, I’d have $58/hour worked! If I kept that money all the way until retirement at 65, it’d be worth over $300/hour worked! Not bad at all for a summer job.
Time and Rate are the Biggest Factors
The higher your rate of return and the longer you have (which also makes higher return investments like stocks and real estate much less risky) the stronger the impressive force of compound interest. How much you contribute matters too, but not as much as when you start and what you invest in. Take a look at these scenarios. All earned the same return rate on their investments, but contributed different amounts and started investing at different ages, until they were 65.
Jacob started working right after high school. Money was tight, but they still managed to invest $200/month starting age 19. Alexis had some student debt, but worked hard to pay it off by age 30. Once free from debt, Alexis put the $600/month they were paying towards loans into investments. Tyler didn’t really start saving until age 45, but realized they needed to start before it was too late, and contributed $1,000/month. Here’s where they will end up at by the time they turn 66:
Want to play around with your own scenarios? Check out this Google Sheet (Go to File > Make a Copy so you can edit) where you can plug in your own contribution amounts and interest rate to see how your money can grow over time.
The Bottom Line
Saving money is definitely a sacrifice, but the more time you have, the more that sacrifice will pay off. And the higher your rate of return, the faster your money will grow. Even if you’re late to the game, something is better than nothing. All that interest you could be earning is basically “free money” you’re missing out on.
Bonus Question
Suppose an ancestor of yours ancestor bought the equivalent of a single share of the S&P500 back in 1871 for $4.44, reinvested dividends for a total annual return rate of about 9% (and held it in a Roth IRA to avoid taxes), and passed it on to you in 2020 (149 years later). How much would you have? Hint: use one of the tools on this site to find out.
