Compound interest is a beautiful thing. Albert Einstein called it “the greatest mathematical discovery of all time” and “the 8th wonder of the world”. I simply call compound interest my best friend forever (BFF, sorry Jimmy & CT).

Compound interest is the the money you make on an investment that has already been invested and has made interest. It may sound a bit complicated but it’s quite simple; all you need is time, money, and a rate of return.

Invest and forget

Let’s take a look at how much money you would have if you made an initial investment of $1,200 with a 7% interest rate.

  • 5 years – $1,683
  • 10 years – $2,361
  • 20 years – $4,644
  • 30 years – $9.135
  • 40 years – $17,969

A decent return but that’s not exactly a lot of money. Clearly a one time investment is not realistic for retirement planning especially when you factor in inflation.

[fusion_builder_container hundred_percent=”yes” overflow=”visible”][fusion_builder_row][fusion_builder_column type=”1_1″ background_position=”left top” background_color=”” border_size=”” border_color=”” border_style=”solid” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”no” center_content=”no” min_height=”none”][icon name=”share” class=””] Related: Understanding The RRSP Basics

Yearly contributions

What would happen if we invested $100 a month instead for a total of $1,200 a year? Our starting point being $0

At a 7% rate of return

  • 5 years – $7,120
  • 10 years – $17,105
  • 20 years – $50,754
  • 30 years – $116,945
  • 40 years – $247,154

That’s just shy of a quarter million dollars! Not bad at all, but not exactly enough to have a comfortable retirement.

Make it rain

What if we upped our investment to $300 a month or $3,600 a year? Again starting at zero dollars with an interest rate of 7%

  • 5 years – $21,359
  • 10 years – $51,316
  • 20 years – $152,261
  • 30 years – $350,836
  • 40 years – $741,461

Sweet lord that’s a ton of money. Now you see why compound interest is my BFF. To give these numbers perspective; if you waited until you were 45 to begin saving instead of starting at 25 you would be short $589,200. Start saving now!

compound interest graph

We can’t catch up later

In our early 20’s we’ve just starting our career so money is tight. When it comes to our 30’s we’ve got kids and a mortgage to pay for making it even harder to save. These are just excuses; delaying saving is a huge mistake.

We decide to finally start investing at age 45 but to catch up we’ll invest $1,200 a month.

  • 5 years – $85,911
  • 10 years – $207,702
  • 20 years – $625,112

Okay we’ve managed to get sort of close but we’re still off by $116,349 and this is only because we’ve increased our savings rate by 4X. Not terrible, but still not close to the returns we’d get if we started 20 years earlier.

Final word
The best thing about compound interest is that everyone can take advantage of it. Obviously by saving early and saving more you’ll get bigger returns, but regardless compound interest is everyone’s best friend forever. Play around with this compound interest calculator and you’ll see how easy it is to save a million dollars.

compound interest

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11 Comments

  1. Tawcan on November 20, 2014 at 1:30 pm

    Can’t agree more. It’s too bad that so many people aren’t taking advantage of compound interest.

    • Barry Choi on November 20, 2014 at 1:52 pm

      I suppose it should be no surprise since I imagine not that many people even know what compound interest means.

  2. Brian So on November 20, 2014 at 7:50 pm

    It’s your best friend when investing, but worst enemy when paying down debt 🙂

    • Barry Choi on November 20, 2014 at 8:10 pm

      Brian,

      Ha good point, people often forget how much interest you pay in the long run when you have a massive mortgage.

  3. […] at Money We Have explains why compound interest is his best friend when it comes to investing. This is one of the main concepts in investing, and how combined with […]

  4. Roberta on September 11, 2017 at 7:13 pm

    Hi Barry, what kind of investments are you using for your calculations? Would it be like mutual funds? I’m just getting my feet wet in the personal finance world, pardon my simple question.

    Cheers,
    Roberta

    • Barry Choi on September 11, 2017 at 8:09 pm

      Hi Roberta,

      For illustration purposes, I used 7% for my calculations. This does not apply to a specific investment. That being said, I tend to used a 4-6% return when I’m trying to project my investments (ETFs or mutual funds). Fixed income investments would yield much less.

  5. Airene on November 5, 2017 at 12:37 am

    I don’t know why people give examples they always say 7 or 8% like the financial advisor at my bank. But in reality I think it’s more or less 1-1.5% when I check my statement. So I am very curious what kind of investment yield 7% or even 4-6%? I currently have mutual funds for RRSPs

    • Barry Choi on November 6, 2017 at 8:02 pm

      Hi Airene,

      I used 7% just for illustration purposes to show how strong compound interest is. A good estimate for planning is 4-5%. If your mutual funds have only been yielding 1-1.5% over the last few years, there’s a good chance that the fund you have chosen is a bit conservative.

    • Frank Mifsud on September 28, 2019 at 2:41 pm

      They want to impress us with a high end results. My question is how do I calculate a compounded interest for 5 years using a deposit of $100000 at 2.70%?

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