The Power of Compound Interest (from $125 to $1M)
May 25, 2024Read time - 3 minutes / Disclaimer
Today let's review the power of compound interest.
Learning how an investment goes from $125 per month to $1M can help you:
• Understand compounding.
• Use it to leverage time.
• Use it to grow wealth.
Unfortunately, compound interest isn't easy math.
How Do You Figure It Out?
Figuring out compound interest requires one of these:
• A fancy spreadsheet.
• A cellphone app.
• A calculator.
We'll use a cellphone app.
Last week, I shared the below:
Let's use this to explain how compound interest works in 3 steps:
Step 1: Pick an Investment
The stock market is often used to compound money.
But what do you invest in?
There's so many options...
Warren Buffett, a famous investor once said:
"The goal of non-professionals shouldn't be to pick winners, rather to own a section of businesses bound to do well, a low-cost S&P 500 index fund will achieve this goal."
Buffett is basically saying, don't buy individual stocks.
Buy an S&P 500 index fund instead.
An S&P 500 fund tracks the 500 largest companies listed on the U.S. stock exchange.
When you buy a stock, you have ownership in 1 company.
When you buy an S&P 500 index fund, you have ownership in 500 companies.
Two common S&P 500 index funds are:
• Vanguard S&P 500 ETF (VOO)
• SPDR S&P 500 ETF (SPY)
Most people can invest in an S&P 500 fund in their retirement account at work.
Step 2: Pick an Amount
Emily and Michael each chose to invest $125 per month.
They didn't want to research and keep track of individual stocks.
So, they invested in an S&P 500 fund instead.
Step 3: Pick a Timeframe
Emily began investing at 25.
Michael began investing at 40.
They both planned to work until age 65.
Let's review Emily's outcome.
Over the last 40 years the S&P 500 averaged 11.606% per year.
Here's how her money grew:
Michael did the same as Emily but for 25 years instead of 40 years.
His balance is $106,557.
Emily has 10 times more money than Michael.
And they're both 65 years old.
Does this mean Michael shouldn't have bothered investing at 40 years old?
Not at all...
It simply means Emily is 15 years ahead of him.
If he sticks with it, his account balance will continue to compound.
The idea behind this example is to show the difference between:
• Investing early in life.
VS
• Investing later in life.
The sooner you start investing, the sooner your money begins to compound.
Conclusion
Albert Einstein called compound interest...
"the 8th wonder of the world".
Over long periods of time, smaller amounts of money can grow into larger amounts.
$125 per month can grow to $1M.
If you want to run your own compound interest estimates, here's the ​free calculator app​ used above for Apple or Android.
There's a "compound interest" option that's easy to use.
If you want to see what the S&P 500 did in the past, here's a link to look up the ​S&P 500 history.​
There's a place to pick the starting year & ending year, then hit "calculate".
Keep building đź’°
See you next week.
