The power of compound interest.

By Abi Tyas Tunggal 15 March 2018 3 min read

If I offered you:

  • $1 million a day for a month, or;
  • a chessboard where I place coins on a square each day, so that one cent is placed in the first square, two cents on the second and so on, doubling the number of cents on each subsequent square, each day.

Which would you pick?

If you want more money, pick the chessboard.

$1 million a day for a month is $30,000,000, assuming 30 days in a month.

Whereas, the chessboard totals ~$18,446,744,073,709,551.62

Why? Because 264–1 = 18,446,744,073,709,551,615.

The chessboard shows exponential compounding return. Exponential means, constantly getting larger.

The important thing is understanding the power of compounding interest, and how a little can become a lot over time.

Hypothetically, you decide to invest $10,000 today, and you earn an average annual return of 10%

compound interest example over 4 years at 10%

In 20 years; your $10,000 becomes $67,275. Remember, compound interest takes time.

Australians are Lucky

Your employer takes 9.5% of your pay and uses it to fund your Super, an investment and saving vehicle for retirement purposes. We can’t touch our Super until we retire. That means decades of potentially compounded growth.

The same happens when you invest in the share market. If you're young, you have a long time allow compound interest to work.

Your biggest asset as a young person is time.

Even if you don’t have much money now and it seems impossible to buy a home, if you can contribute a little more today, it may be a lot later because it will have time to compound.

By the time you reach an important life milestone or even retire, your money would have compounded for decades and hopefully, you’re in great financial shape.

Compound interest’s effect is large over decades and the more you can put away today, the more you will end up with tomorrow through interest and capital appreciation. Short-term volatility won’t seem as important as it does today, when you’re retiring in 30 years.

Even if you start with a small amount the more you can put away today, the greater the effect.

Consider the example above (an average annual return of 10%), except this time you invest an additional $5 a day or $1,825 a year. For simplicity, let’s ignore the extra day in leap years.

compound interest example at 10% over 4 years with additional $5 a day

In 20 years, the total would be ~$171,802. Even small amounts today can be a lot later given time to compound.

That’s why it’s so important to be unable to touch your superannuation and develop investing discipline. It can only be released if a condition of release is met. It needs time to compound.

Time is Your Friend

As a young person, you have an advantage because you have time. The sooner you invest, the longer compound interest can affect your long-term results.

Don’t be discouraged because you can’t invest much now. You’ve got time on your side and the benefits of compound interest over time are large.

As Albert Einstein said, “compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

For most investments, it may be best to start early, be consistent, and leave your money alone.

Australians are lucky.

One thing you can think about is if you want to contribute a little more?

The power of compound interest.