Understanding the Power of Compound Interest

What is Compound Interest?

Compound Interest is a financial strategy that describes how an initial investment can grow over time when the interest or dividend earned is reinvested. Thus, the investor not only earns a return on the initial investment but also a return on the interest or dividend itself.

Over longer periods of time, Compound Interest can allow your money to grow exponentially. This strategy can be very effective for retirees. This is the case since senior citizens worry less about returns and seem more concerned about turning their retirement assets into reliable & predictable retirement income.

Additionally, various senior citizen studies have shown that those with guaranteed or more predictable incomes are happier and less stressed during retirement.

The Formula for Compound Interest

Example:

$1,000, 6%, 10-Years period, Compound Annually = 1000 (1+.06/1)^10 = $1,790.85
or Compound Interest (interest on interest) @6% over 10-Years produces $791
Using the same example, 20-Years of Compound Interest produces $2,207

Compound interest grows rapidly with the passage of time and consistent reinvestment. In this example, the total interest earned grows from $419 after 6-Years, to $1,012 after 12-Years, $2,207 after 20-Years and $4,743  in Year 30.

The Impact of More Frequent Compounding

There are two key observations from the table above. First, more frequent compounding results in higher ending balances. Second, longer holding periods result in exponentially larger ending balances.

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

“Compound Interest is like a snowball rolling down a long hill, picking up more snow as it gains momentum until it becomes a massive snowball”. – Warren Buffet