The Magic of Compounding Interest

The biggest reason to start investing when you are young is what investors like to call "the magic of compounding interest." What is the magic of compounding interest? Let me try to explain in simple terms.

The longer you leave your money invested, the more likely it is to grow because of compounding interest.

Compounding interest is how the money you invest builds upon itself over time. The "magic" part is that you begin to earn interest not just on the original amount of money you invested, but also on the interest. In other words, you earn interest on your interest and your wealth begins to "compound." Compounding interest is one of the great benefits of long term investing.

Here's an example: Let's say you invest $1,000 today in the S&P 500 index. The S&P 500 is an index that tracks the performance of the 500 largest companies traded on the stock market. (More on how to invest in the S&P 500 index in an upcoming post). Since the S&P 500 was formed in 1957 it has returned about 10% annually. Some years it has gone down, or lost value, like in 2008 when it fell -38.5%. But when you average all the years combined dating back to 1957, it has returned 10% per year. For this example, lets assume that continues. So back to our $1,000 investment in the S&P 500 index. If you make 10% annually, in 10 years your $1,000 investment will be worth $2,593. In 20 years it will be worth, $6,727. In 30 years, it will have increased to $17,449. In 40 years, it will be worth $45,259. Not bad, but here's where the magic really happens. If you keep the money invested for just 10 more years, at the 50 year mark it will be worth $117,390.

Source: Nerd Wallet https://www.nerdwallet.com/calculator/compound-interest-calculator

Let me just reiterate what the graph shows us: A $1,000 investment earning 10% a year would be worth $117,390 in 50 years!!! That is why it is so beneficial to start investing as a teenager!

If you want to do some calculations with different amounts to see how your money might grow over time, click on this link to Nerd Wallet's Compound Interest Calculator

Overall, compounding interest is a great way to build significant wealth over time because your money will grow at a faster rate the longer you keep it invested.

But remember: There is always the possibility that you can lose the money you invest, which is not so magical :( That is why investment professionals advise that you diversify your investments and not put all of your money in just a few investments.