The Power of Compound Interest

Nov 29, 2006 by

Every personal finance columnist seems to write about compound interest, so I will as well. I hate to be cliche, but compound interest is simply that important. The following table illustrates a few key points:


Year 5% Lump 10% Lump 5% Per. 5% P/L  
2006 $100 $100 $100 $100  
2007 $105 $110 $205 $205  
2008 $110 $121 $315 $315  
2009 $116 $133 $431 $431  
2010 $122 $146 $553 $553  
2011 $128 $161 $680 $680  
2012 $134 $177 $814 $814  
2013 $141 $195 $955 $955  
2014 $148 $214 $1,103 $1,103  
2015 $155 $236 $1,258 $1,258  
2016 $163 $259 $1,421 $1,421  
2017 $171 $285 $1,592 $1,492  
2018 $180 $314 $1,771 $1,566  
2019 $189 $345 $1,960 $1,645  
2020 $198 $380 $2,158 $1,727  
2021 $208 $418 $2,366 $1,813  
2022 $218 $459 $2,584 $1,904  
2023 $229 $505 $2,813 $1,999  
2024 $241 $556 $3,054 $2,099  
2025 $253 $612 $3,307 $2,204  
2026 $265 $673 $3,572 $2,314  
2027 $279 $740 $3,851 $2,430  
2028 $293 $814 $4,143 $2,551  
2029 $307 $895 $4,450 $2,679  
2030 $323 $985 $4,773 $2,813  
2031 $339 $1,083 $5,111 $2,953  
2032 $356 $1,192 $5,467 $3,101  
2033 $373 $1,311 $5,840 $3,256  
2034 $392 $1,442 $6,232 $3,419  
2035 $412 $1,586 $6,644 $3,590  
2036 $432 $1,745 $7,076 $3,769  
Ratio: 1.00 4.04 16.37 8.72

This table illustrates three investment strategies. In the first column, the person invests $100 in 2006 at 5% per year, and then does nothing further. In the second column, the person makes a similar investment, but at 10% per year. In the third column, the person invests $100 every year (i.e. a payroll deduction) in an account earning 5% per year. In the fourth column, the person invests $100 every year (through a payroll deduction) until 2017, after which he does not add additional money. In the fourth column, it is assumed the person received a 5% return on his investment each year. In the “Ratio” row, you can see how all of these investments faired relative to one another.

Here are the key points to take away from this table

    Doubling the interest rate of the investment more than doubled the return. In 2036, 10% was not twice as good as 5%, it was over 4x as good!
    Annual contributions are key to wealth accumulation.
    It is better to be aggressive early when saving than later. If the person stops making contributions after ten years, they end up with about half as much as the would have if they hadn’t stopped. Nonetheless, the person still ends up with almost nine times as much as if aggressive early contributions had not been made.

What is the cost of starting late? If you want to know how much money you would have if you started in ten years (i.e. 2016) instead of starting today, simply look at the totals in the 2026 row. In the first and last investment scheme, a late starter would only make 61.4% as much as an early starter. In the second and third schemes, the late starter would make 38.6% and 50.5% as much as an early starter. As you can see, there is a huge cost to starting late!

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