“My wealth has come from a combination of living in America, some lucky genes, and compound interest.”
– Warren Buffett
This week we are looking at the last item in Buffett’s quote – Compounding Interest.
The quote was going to be a quote attributed to Albert Einstein – “Compounding interest is the most powerful force in the universe”. But although often cited, there seems to be a lot of evidence that he never made such a remark….so I chose Buffett’s quote instead.
The key to compounding interest is time. Over long periods of time, even what seems like small gains can compound into large sums. Today we look at a couple examples of compounding in action. Tomorrow in our Chart of the Week we look specifically at how Buffett’s wealth has compounded over the years.
Consider a simple $5000 investment today that grows and you forget about for 30 years – how big does it grow?
After 30 years your one-time $5000 investment has more than quadrupled to about $22,000!
Sure the first year that $5,000 “only” makes $300 – boring investment right? But the beauty of compounding interest is not what happens in one year – but in 30.
Because what is exciting is that after 30 years your one time $5000 investment is now making over $1,000 per year – a 20% return on your original investment:
We are only beginning to see the exponential growth that compounding interest leads to. The effects only grow over time.
For a 25 year old investor today, 30 years could actually be too short of a time frame – their investment window could easily be 50+ years. Ready to see your one time $5000 investment explode even higher?
And your one-time $5000 investment is now earning $2,700 per year! – what would be a 54% return on your original investment!
Here is how our chart above looks as we extend our investment horizon to 50 years long:
So when you hear people talk about the importance of starting to save early – this is why! $5000 can turn into $50,000 with just modest returns – but you need time. Waiting just 1 year to start saving that $5,000 costs you $2,700.
You can see this saving in action in another post – “How much do you have to save each year to reach 1 million dollars – by age”
Tomorrow we look at how Buffett has benefited from compounding interest – check back then, or sign up for our mailing list and get these weekly posts emailed directly to you:
