It’s the principle on which most great fortunes are built, and it’s far more powerful than you might imagine.
In this video, financial author and educator Andrew Craig explains compounding.
Andrew Craig believes “one of the great failures of our education system that too few people understand is the power of compound interest”.
However, what exactly is compound interest?
“Compound interest is where you take $1000, let’s say. You make ten per cent in over, let’s say, one year. So at the end of the year, you have $1100. If you do that again, the following year, you make $110 in return so you’ve got $1210. And crucially, that $10 is the return on your return. That is the beginning of compounding”.
Essentially, compounding means the return on your return, and what that means is that the curve gets steeper over time and the return on your return increases.
To illustrate the power of compounding in the talks that he gives, Andrew uses a simple example.
“If on the day a child is born, a wealthy relative or parent puts $5000 into some sort of investment, and that investment returns ten per cent per annum. On the first day that child can legally retire, on their 55th birthday, they’ll have $945,000 in their account. So I always say, how can we possibly have a pensions crisis? How can people struggle financially if a one-off investment of $5000 can imply that somebody’s got nearly $1million by the time they retire?”
So, harness the power of compounding. If you haven’t started investing yet, don’t put it off any longer.
And if you want to give a child a financial headstart, just invest some money for them. Simply leaving it invested will produce extraordinary long-term results.