Hi y’all —
Trick or treat! I prefer treats, and I prefer them to be chocolate. But you know what the ultimate treat is?
Compound interest.
Wait, wait! Don't delete this email. Hear me out!
It's a topic that comes up with remarkable frequency in my interviews. In fact, I just searched the phrase "compound interest" on Money's website, and it makes an appearance in over 230 articles going back to 2012. Experts particularly like to refer to compound interest as "magic" — legend has it even Albert Einstein was a fan, famously saying "Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it."
But what is compound interest, and what makes it so great?
I got in touch with Julie Guntrip, financial wellness expert at Jenius Bank, to find out. She started with a definition: "Compound interest is when the interest earned on a balance is calculated not only on the original principal amount but also on interest already accrued," Guntrip writes in an email.
Compound interest lets me earn interest on interest, basically, which can create a snowball that just keeps getting bigger with time.
"It may feel like magic because of this exponential growth potential," she says. "What starts as a small increase could substantially increase over many years if left untouched, effectively making your money work for you on autopilot."
Here's an example. Say I put $1,000 into a deposit account that earns 5% interest annually. After a year, my balance will be $1,050.
But then the next year, I won't earn another $50 — I'll earn 5% of that slightly bigger balance, meaning I'll generate $52.50 and, once it's added to what I already have, end year 2 with $1,102.50 total. When that happens again in year 3, I'll have $1,157.63, and so on.
If I leave it all untouched, I'll end up with $1,628.89 after a decade. After 20 years, my sum will be $2,653.30. And once that account turns 30, the balance will be $4,321.94 — over four times my original investment.
I will have quadrupled my money, and I didn't even have to do anything.
The numbers are more impressive if I start with a higher initial deposit. After one year, a $50,000 deposit with a 5% interest rate that compounds annually will become $52,500. After 30 years, it'll be a whopping $216,097.12.
Guntrip says that because time is so crucial here, young people tend to benefit the most from compound interest. The longer a person is able to let their account generate compound interest, the more it expands. That's why financial experts heavily encourage folks to start saving as soon as they're able to, even if it's just a small amount.
