The Compound Interest Formula And How Albert Einstein Discovered It

So you’d earn more money in the last 10 years than in the first 20. After 10 years, your original $1,000 would become $2,010. That means your annual interest would be $1,010 – more than your original investment. The longer you leave your money untouched, the more powerful the compounding effect becomes.

The longer you invest, the more important dividends become. “For the seriously long-term investor, dividends are where the action is,” he says. Back to Albert Einstein

With such potential for astronomical growth, it’s no wonder Albert Einstein called the power of compound interest the most powerful force in the universe. The problem though, is that there is substantial doubt he actually said that.

Albert Einstein – Compound interest

But if you break out your calculator and double one penny for 30 days you will be amazed that on day 30 your penny would be worth over $5,000,000. That’s why it’s in your best interest to start investing from as young an age as possible. And the longer you give yourself to benefit from it, the wealthier you stand to become. And it’s something you should aim to take advantage of.

This year instead of earning $100 dollars you earn $110. The 10 extra dollars are due to compounding as you have earned a return on your accounting guidelines for contingent liabilities return. This doesn’t seem like very much but the secret with compounding is to amplify it by investing for long periods of time.

  • If you use it to your advantage with your investments, it will make all the difference over the long term.
  • In the US, Procter & Gamble has increased its dividend every year for the past 56 years.
  • ’ Albert went on to invest his prize money into the stock market, but unfortunately when the market crashed in 1929 during the Great Depression it resulted in him losing the majority of his investments.
  • On top of that, he had a knack for simplifying complex concepts, making them understandable for all.
  • He wasn’t known for his investing abilities, but he did identify the most amazing mathematical revelation known as ‘compound interest’.

Most people would go for the $10 million option as it is hard to imagine that $1 doubling 30 times will become $1.07 billion! This is the power of compound interest – your principal would accumulate with interest earned during the investment period, yielding more returns. The longer the investment period, the more you will benefit from compound interest.

Imagine this scenario – you’re 35 and you start to implement this change where you’re going to save $5K/year until you’re 50. That first year you did make $500, or 10% on your $5K investment. But, in Year 2, you’re going to make 10% on your $5,500 invested rather than just the $5K that you initially put in. For the first couple years of my investing journey, I really didn’t fully comprehend what he was meaning when he said this. Of course I understood that the reason why investing can be so lucrative is because of compound interest, but what I didn’t fully get was that those that don’t understand compound interest “pay it”.

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In personal finance articles I frequently find quotes injected to attribute some further relevance to one’s position. All investing involves risk including loss of principal. No strategy assures success or protects against loss. If we use compound interest for good, we can harness its incredible power to help propel us forward. Einstein didn’t just say that it was pretty cool or good in some way; he said it was the most powerful force. Einstein suggests that compound interest can work for you or against you.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

One of my favorite compound interest examples that I like to use is the power of making small changes in your everyday life and then sitting back and watching the money compound like crazy. To me, the #1 easiest change to implement is simply to stop going out and buying lunch every single day at work. Historically, the S&P 500 has returned about 10% on average, but just to be a little bit conservative, let’s go ahead and use an 8% return because I’d rather underpromise and over perform.

Never blindly pursue high-return investments

“That is slowly changing. Japanese companies are starting to pay income. So are many in China and the Far East.” It is the same story in the United States, Mr Dowding says. “One-hundred dollars invested at the end of 1925 would be worth $9,229 today if you had spent the dividends, but $299,395 if you had ploughed them back into your portfolio.” It will also allow me an opportunity to come clean on my use of this quote. For continuous compounding, 69 gives accurate results for any rate, since ln(2) is about 69.3%; see derivation below.

There is no age limit for learning!

After a year, if you don’t pay anything back, you’ll owe $180 in interest, making your total debt $1180. Now, what if this interest starts to earn its own extra money? So if you are telling yourself that you will put aside money for tomorrow “when you can afford to” or “when you make more money” or whatever, you are putting yourself at a huge disadvantage.

Nowadays it’s somewhat hard to go out to eat for under $10, and then you can tack on a 20% tip and end up at $12 pretty quickly. Take the previous example – after five years, you’d not only be earning interest on your original $1,000 investment, you’d also be earning interest on your $403 of interest. He said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” The Ascent is a Motley Fool service that rates and reviews essential products for your everyday money matters. But if you’d rather grow your money into a larger sum over time, then investing it is your best bet. And the sooner you start investing, the more wealth you stand to accumulate.

Thanks to the power of compounding, you’d earn $34,370 in the third decade compared to $26,612 in the first two decades – that’s 29 per cent more money in half the time. The above example of doubling a dollar a day may sound unrealistic. However, in the real world, many do expect to have their investment returns double within a short period of time But the fact remains, the higher the potential returns, the higher the risks.

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