Tuesday, April 7, 2009

Compound Interest – A Natural Law of Money

When asked what he considered the most powerful force in the universe Albert Einstein answered, “Compound interest!”

Compound interest bored me for years. I squandered those years failing to use this natural law of money. George Bernard Shaw’s saying, “Youth is wasted on the young.” is appropriate - few young people save and invest for their future - until the future is now or at least very soon. Those few, however, who persist in saving and investing end wealthy by any reasonable standard.

The natural law of compound interest can work for you. As an example, the table below shows the results if a person invests $100 per month at a 10% rate of return for either 10, 20, 30, 40, or 50 years without withdrawals.

Years End Value
10 ------ $20,484
20 ------ $75,937
30 ------ $226,049
40 ------ $632,408
50 ------ $1,732,439

In ten years this investment plan yields $20,484, in fifty years $1,732,439.

The natural law of compound interest can also work against you; this table shows how a $10,000 debt incurring 10% interest would grow if no payments were ever made.

Years End Value
10 ------ $27,070
20 ------ $73,281
30 ------ $198,374
40 ------ $537,007
50 ------ $1,453,699

The amount owed would grow from $10,000 to $27,070 in ten years and to $1,453,699 in fifty years.

The formulae for calculating present values or future values are well documented. They can be found at here, if you are so inclined.

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