Compound Interest
Compound interest is interest earned on interest. Small, steady contributions grow into large sums when given enough time.
The formula
A = P * (1 + r/n)^(n*t)Where P is principal, r the annual rate, n times compounded per year, and t years.
A worked example
Invest $5,000/year at 7% return from age 25 to 65:
- You contribute $200,000 out of pocket
- It grows to roughly $1,078,000
The first $5k does most of the lifting, because it has 40 years to compound.
The three levers
- Rate of return — hard to control; markets decide most of it
- Contributions — fully in your control
- Time — the most powerful and the most limited. Once a year passes, you can't buy it back
The takeaway
Start before you feel ready. The cost of waiting is invisible but enormous.