What is the concept of compound interest? Albert Einstein once said that compound interest is the greatest invention of mankind. On many sites and blogs devoted to personal finance, you can read about how by investing a small amount on a regular basis, using the benefits of compound interest, you can gather quite a substantial sum after many years. Sounds good, but is actually just a few dollars a day enough to get rich? I allowed myself to make the relevant calculations and the results are shown in the table below. But first let me explain what exactly is compound interest. So, repeating after Wikipedia:

“**The concept of compound interest refers to** the interest rate type monetary contribution K, which consists in the fact that such an income as interest is added to the contribution and pays with him the following year. After n years (capitalization – that is, the payment of interest – after a full year) the contribution is equal to: K_n = K \ cdot \ left (1 + r \ right) ^ n, where r is the interest rate.”

That is investing $100 at 10 percent, after a year you get $10 of interest and you have together $110, after two years you’re earning $11 and your financial contribution rises to 121 dollars, in the next year, your interest is already 12.1 dollars and so on. If you stay patient after 10 years your $ 100 will grow to $ 259,37, after 20 years to 672,74, and to $1744,94 after 30 years! As noted, our investment results depend on interest rates and the duration of the investment.

*Why is compound interest better than simple interest?* The point is simple, the longer you invest, the more visible is the power of compound interest.

So, whether by giving up cigarettes and investing $5 a day, do you have a chance to become a millionaire? In the table below I posted the calculation of how much money a 20, 30, 40 and 50 years old would have to put off every month so at the age of 65 be able to enjoy a million dollars.

In my calculations, I accepted quite optimistic 8 percent rate of return, the same for each age group. The variable is of course the investment period of 15 years in case of 50 years old up to 45 years in case of 20 years old.

Conclusions? A twenty year old student can really build an impressive capital regularly saving 150-200 dollars a month. 50 year old giving up smoking and thanks to investing $ 150 every month, at the time of retirement might collect around 50,000 dollars. Well, he won’t be a rich man, but definitely will be healthier and fitter, and with $ 50,000 will be able to celebrate the fact that he retired by going on an exotic trip. The conclusion is one, start saving as soon as possible and do it regularly, then even a small amount will likely grow to seven digit values.

John Said

03/30/2014

Investing Theory