Compound interest is the 8th wonder of the world.
One needs to understand the power of compounding. 1% a day means you'll have improved something 3800% by year's end.
Supposedly, Albert Einstein said that "compound interest is the 8th wonder of the world. He who understands it earns it; he who doesn't will pay it."
My very first article gave a brief overview of how I got started at the age of 15.
Many lessons learned later, and we are saving a small monthly amount into index funds for our twin boys, getting them started 14 years earlier.
The Rule of 72
This rule is a simple way to roughly determine how long an investment will take to double with a fixed annual interest rate. By dividing 72 by the annual interest rate, you obtain how many years it will take for the initial investment to duplicate itself.
For example, assuming a 7% annual return, we are talking about ~10 years to turn €10,000 into €20,000.
Getting to €100k
Saving up an initial €100,000 is hard, hard work. It takes discipline and patience.
Ultimately, it becomes more fun as the power of compound interest starts to kick in. With every passing year, it will increase your net worth at an increasing rate.
For simplicity's sake, let's assume that we can save €10,000 per year.
Investing in a broad index fund with low costs will have returned around 7% after inflation in the past. Let's assume that this return will stay the same in the future for anyone who will invest for the very long term (decades).
At a 7% annual interest rate, your net worth will grow to 100k in 7.8 years.
Let's look at a plain Excel Table with some simple calculations behind it.
Your net-worth would increase to 200k just 5.1 years later.
The invested money in the prior year is working for you behind the scenes!
Going down the table, you can see the power of compounding kicking in.
At 500k, getting to 600k would only take two years!
If you aren't into Excel, you can also use various online calculators such as this one.
I would encourage you to learn the Excel formulas for compound interest to understand the math behind it in greater detail. It is not that scary, and it will help cement the concept in your brain.
By the way, to go from 600k to 1 million would take less than seven years. Insane!
Understanding this certainly had a motivating effect on my life.
Key Takeaways
The system is in your favor.
Monetary inflation, an increase in productivity, continued innovation, population growth, are some factors that cement my belief that the stock market will reward those who stay invested for the very long term — ignoring all down and upswings in-between.
You have to start, no matter what the amount may be, and have the discipline to add to your savings every single month for years and decades to come.
IMPORTANT: In the beginning, the amount you save matters far more than your investment returns.
The magic of compound interest, unfortunately, doesn't reveal itself until you cross the $100k net-worth mark. It's around that point that you have enough savings for compounding to have a noticeable impact.
Then, the snowball will continue to roll faster and faster until you can't keep up with it anymore.
Just get started. A low-cost index fund with a monthly saving plan on autopilot takes almost no effort setting up.
Don't spend vast amounts of time on picking individual stocks when you enter the working life. Put your energy and time into advancing your career instead. Increase your income, and thus the amount you can save in the years to come.
Finally, never get discouraged if it takes you longer than you hoped to save your first 100k.
Thank you for reading this far.
If you found this useful, you can subscribe below and receive future articles for free right in your inbox.