I already mentioned several times here how important it is to invest for the long term and that compounding interest is a powerful tool. It gets more powerful the longer you use it. Why? The answer is very simple: because the money you make on your principal starts making money too!
As an example: Start with $10,000 earning 10% interest. At the end of one year, you have $11,000. The next year, your starting capital of $ 10,000 plus the earned $ 1,000 from interest the year before earns 10% now. So, instead of making $1,000 in interest on $10,000, you’re making $1,100 in interest on $11,000.
That extra $100 may not seem like much in the first year but see what’s happening over a longer period: By year 5, you’re making $1,464 in interest (46% more) and you have $16,105 at year-end. By the end of year 8, your account has more than doubled. In year 9, your interest is more than twice the original $1,000. And after 10 years, you’re making $2,358 in interest and your account is up nearly 160% to $25,937.
But it is getting better and better. If you do not touch your money, after year 15, you’re earning 4x your original interest and your account is worth a staggering $45,950!!! After 20 years, your interest payment is $6,727 and you have more than $74,000 in principal.
It took 9 years to double your interest payment and 8 years to double your account, but only 6 years to double it again. In less than 25 years, you earn more interest every year that your principle amount you invested!
That is the power of compounding! If you simply took out the $1,000 per year in interest and spent it, your savings would never grow and your interest payment would remain at $1,000. After 20 years, you’d still be collecting $1,000 in interest instead of the $6,727 you would be receiving if you had let it compound.
It is as simple as that: the longer you can let your money compound, the more money you will make and the more your principal will be worth!
Sven Franssen