The Power of Compounding

Albert Einstein called compound interest is "the greatest mathematical discovery of all time."

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  1. NotMe commented on Jan 22

    I’d really like to know when and where Einstein
    said that. Even if he did, is it worth quoting
    him, most likely out of context? You don’t have
    to be a genius to know what an exponential growth
    is. These sort of quotes only serve to
    profane the source.

  2. Barry Ritholtz commented on Jan 22

    “Compounding is mankind’s greatest invention because
    it allows for the reliable, systematic accumulation of wealth.”

    http://www.word-gems.com/wealth.compounding4.html

    ~~~~~~
    Einstein calls compounding the “8th wonder of the world.” http://mutualfunds.about.com/cs/mutualfunds101/a/compounding.htm

    ~~~~~~

    “Compounding,” Albert Einstein said, “is mankind’s greatest invention because it allows for the reliable, systematic accumulation of wealth.” Einstein was a smart man. But you hardly have to be a genius to make this concept work for you.

    http://moneycentral.msn.com/content/Investing/Startinvesting/P62459.asp?special=0512wealth

    ~~~~~~~~~~~
    “The most powerful force in the universe is compound interest”

    Albert Einstein quotes (German born American Physicist who developed the special and general theories of relativity. Nobel Prize for Physics in 1921. 1879-1955)

  3. John East commented on Jan 22

    What I’ve always found strange is that something so apparently obvious and simple to grasp very rarely happens in the real world. How many people do you know who retire with $1million from a small investment they made when they were young?

  4. cm commented on Jan 22

    John East: How do you know that? Ever heard of trust fund babies?

  5. Mover Mike commented on Jan 22

    Oh, To Be 19 Again, Knowing What I KNow Now!

    The Big Picture reminded me of a chart that Richard Russell of Dow Theory Letters used to run about the power of compounding. This chart should be posted on every school…

  6. M1EK commented on Jan 22

    cm, “trust fund babies” are defined by most as those who never had to work at all, not those who made some good investments at the beginning of their career.

    John, the reason you don’t hear about is is that a million bucks for that 65-year-old isn’t worth anything remotely close to a million bucks in the currency of that 19-year-old. Inflation exists in the real world, and eats away a large chunk of these ‘gains’.

  7. M1EK commented on Jan 22

    For instance, assuming 4% inflation, the $2000 that worker A contributed at age 26 was equivalent to a bit more than $1500 of worker B’s “19-year-old” money. It gets much worse later, of course. Worker A’s contribution at age 65 is a small fraction of Worker B’s original $2000.

  8. D. commented on Jan 22

    John East:

    In 1957 the average annual salary was around 4700$.

    For a today’s 65 year old to have saved 2000$ per year 45 years ago would have entailed putting aside 43% of his gross annual income. And considering that couples had their children earlier in those days, saving 2000$ was a pipe dream.

  9. Dan Green commented on Jan 22

    Ben Franklin said it, too: “A man has three great friends: an old wife, an old dog, and compound interest.”

  10. cm commented on Jan 23

    M1EK: Of course trust fund babies don’t make the investment, but have the investment made on their behalf. But does who pays the money make a difference here? OTOH my remark was half tongue-in-cheek.

    Good point about inflation. But while that will weaken the point, it will not invalidate it (with a positive net interest rate that is).

    The “power” of the above presentation is that the early saver comes out ahead. Including inflation, or an adjusted net interest rate, it should perhaps be modified to show how long it takes to catch up to an early investment using “PPP equivalent” amounts.

  11. John East commented on Jan 23

    Thanks for the answers. There were a lot of good points made.
    The power of investing when young is certainly impressive, but inflation takes the shine off it a bit. Also, the potential gains of locking into an investment for forty years or so must also reflect the increased risk. If you can keep turning a healthy profit every year I think you deserve your $1 million retirement prize.

  12. fred krueger commented on Jan 27

    Of course, the real question here is the compunding rate. At 10%, its true, an individual need only save in their 20s and they will have a very nice nest egg at retirement. However, more realistic are these numbers:

    50% split between bonds and stocks. Bonds return 5% Stocks 7% — lets say 6% on average. After fees, 5% is a good annual number. After taxes: 3 – 3.5 %. After inflation — zero.

    Bottom line: fees, taxes and inflation together imply a long term real interest rate of close to zero. There is no compunding effect.

    The one caveat is real estate — bought at the right time and never sold. I am guessing the long term rate of inflation on real esate is just above the rate of inflation. Add rent and subtract out costs and i think you get to a 2-3% real long term ROI. Not bad, but certainly no where near 10%.

  13. KJ commented on Feb 26

    Question…if compound interest doesn’t exist…how is it that over the course of 5 years I invested $15000 and now have $40,000? Now this money was DCAed (Dollar Cost Averaged) into one mutual fund.

    I’ll give you real estate is a good investment. And that $40,000 doesn’t go as far is it once did, but to say that it doesn’t exist is a bit, I hesitate to use the word ignorant.

  14. believer commented on Mar 21

    True story- I saved every spare penny I could, starting at age 18. The amount varied from $3,000 to $22,000 per year. No, I never drove a new car, had HBO or wore designer clothes. Now at age 47, I am retired with a healthy 7 figure bank account and don’t owe a cent. Average return of the stock market is over 10% per year, look it up. Bottom line is this- live below your means, spend the same amount as your income grows and learn to invest on your own. The world is full of get rich quick schemes- don’t listen, just pay your dues and study investing. The upside is I get to be very involved in my children’s lives. The down side is the only people I have to hang out with are 20 years older than me. Everyone my age is still working.

  15. believer commented on Mar 21

    True story- I saved every spare penny I could, starting at age 18. The amount varied from $3,000 to $22,000 per year. No, I never drove a new car, had HBO or wore designer clothes. Now at age 47, I am retired with a healthy 7 figure bank account and don’t owe a cent. Average return of the stock market is over 10% per year, look it up. Bottom line is this- live below your means, spend the same amount as your income grows and learn to invest on your own. The world is full of get rich quick schemes- don’t listen, just pay your dues and study investing. The upside is I get to be very involved in my children’s lives. The down side is the only people I have to hang out with are 20 years older than me. Everyone my age is still working.

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