Compound interest – investors best friend.
I didn’t quite know where to start with this post. So I decided to go back to school. In particular to my school maths lessons and Friday afternoons. Yep, that’s right maths on a Friday.
What kind of person would schedule two hours of maths on a Friday afternoon? A teacher I guess. At the time it was a lesson I dreaded – I mean, a Friday afternoon and double maths – c’mon.
Anyway, it didn’t do me any harm – quite the opposite in fact. It was in these long tiring Friday afternoon maths lessons that I was properly introduced to compound interest. I liked it then – and I love it now!
This is why?
The concept is very simple.
Compound interest is simply interest added back to the original or principal sum and then more interest is earned or calculated on ‘that’ added interest over the next compounding period.
Like this…Year one…
Over a one year period: Take £1000 capital and add 5% interest (lucky if you can get it). That equals to £1050. That’s 1000 x 5% over 1 year = £1050.
Now this is the best bit…
Take your £1050 from the first year (original capital plus interest). Now, in year two it goes like this…
Take the new value £1050 capital add 5% interest again (but this time it is added to £1050 not just the original £1000).
That’s 1050 x 5% equals £1102.50 we’re compounding the interest on the £50 earned in the first year as well as the original capital.
In the third year…
It will be £1102.50 x 5% = £1157.63 and so on.
You can clearly see why it is important to take advantage of compound interest. Leaving your money in a savings account right now with such low interest rates isn’t a wise option. But when/if you can find a sensible interest rate COMPOUND interest will be your best friend.
Don’t just take my word for it. Compound interest is in very good company.
Albert Einstein said this about it…
‘Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.’
He called it, ‘the greatest mathematical discovery of all time.’
Look at this table. It shows what £100,000.00 over 10 years will be worth if you add the interest back to the capital every year and compound it for 10 years.
Capital of £100,000.00 with 5% compound interest added over 10 year period
Year 1 £105,000.00
Year 2 £110,250.00
Year 3 £115,762.50
Year 4 £121,550.63
Year 5 £127,628.16
Year 6 £134,009.56
Year 7 £140,710.04
Year 8 £147,745.54
Year 9 £155,132.82
Year 10 £162,889.46
Interest at 5% compounded over 10 years
Year 1 £5,000.00
Year 2 £5,250.00
Year 3 £5,512.50
Year 4 £5,788.13
Year 5 £6,077.53
Year 6 £6,381.41
Year 7 £6,700.48
Year 8 £7,035.50
Year 9 £7,387.28
Year 10 £7,756.64
Other types of interest are available – but compound is the best.
It’s time to compound your savings.
Get to it!