Start Buying Assets Now to Reap the Reward of Compound Interest!
Start investing now and you will benefit greatly from the magic of compound interest. To take advantage of the magic of compound interest one must start investing now! The average S&P 500 yield over the last 30 years has been 12.7%, which means the index increased 12.7% year-over-year for the last 30 years (the S&P 500 index is explained later). If you would have invested $100 in an S&P 500 index mutual fund 30 years ago that money would have grown as follows:
|
Original investment: |
$100.00 |
|||||
| Year |
Interest |
Running balance |
|
Year |
Interest |
Running balance |
|
1 |
$12.70 |
$112.70 |
|
17 |
$86.02 |
$763.32 |
|
3 |
$16.13 |
$143.14 |
|
19 |
$109.25 |
$969.51 |
|
5 |
$20.49 |
$181.81 |
|
21 |
$138.77 |
$1,231.41 |
|
7 |
$26.02 |
$230.92 |
|
23 |
$176.25 |
$1,564.05 |
|
9 |
$33.05 |
$293.30 |
|
25 |
$223.86 |
$1,986.54 |
|
11 |
$41.98 |
$372.53 |
|
27 |
$284.33 |
$2,523.17 |
|
13 |
$53.32 |
$473.16 |
|
29 |
$361.14 |
$3,204.75 |
|
15 |
$67.72 |
$600.98 |
|
30 |
$407.00 |
$3,611.75 |
Notice how the earned interest in the first year of $12.70 slowly grows to $407.00 by the 30th year, and your $100 magically grows to a grand total of $3,611.75. You make $3,511.75 with $100. That is the magic of compound interest.
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Compounding occurs when earned interest is added to the running balance and every year the same yield (interest rate) is applied to a larger balance |
This is referred to as geometric or exponential growth. This only applies if the earned interest is added to the balance. If you remove the earned interest ($12.70) every year over a 30-year period, your investment would not grow one penny. Where is the magic in that scenario? This illustrates an important principle:
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If you do not reinvest all unearned income, your investment will not grow geometrically. |
Geometric growth has two distinct phases. The phases are referred to as the lag phase and the exponential phase, refer to the graph below.
Notice how slowly the monthly investment grows for the first 25 years (lag phase) then the investment starts growing exponentially. The shape of this plot is not a function of the size of the monthly investment. Increasing the monthly investment from $25 to $250 does not change the plot significantly, please refer to the plot below.
The duration and shape of the lag phase and the exponential phase are essentially the same in both graphs. The lag phase is unavoidable (first 20 years where the line trends horizontally). Things become really interesting in the exponential phase (25-40 years) where the line starts trending upward and eventually reaches for the sky.
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Investors really start to realize the fruits of their work in the exponential phase. Therefore, to become financially independent one needs to starting investing ASAP. |
Long-term investors will earn most of their unearned income after 30 years of investing.
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