approximately 10.5%, then after 30 years you will have $1 million! And after 36 years you will
have over $2 million, but with projected inflation of 3% per year, this will be worth over
$692,000 today dollars! ($100 is 20% of $500. Five hundred dollars per week take-home
income is equal to approximately $24,000 annual take-home income.)
Why is compound interest, or return, so powerful? Why has it been called the Eighth Wonder of
the World? Because it causes savings to grow exponentially, and the key to that is that you get
interest on interest. For example, suppose that you invest $100 just ONCE at 10.5%
(approximately the historical average return of a well-diversified stock mutual fund). What
happens?
Year 1:
You start with $100, your investment, and at the end of the year you get interest equal to 10.5%
of what you started the year with, that is 10.5% x 100 = $10.50.
So you get $10.50 interest, plus you have your initial investment of $100, so at the end of year 1
your account has $110.50.
Year 2:
Now you start the year with your $100 initial investment, plus last year’s interest of $10.50 – and
you will get interest on both! So this year your interest will be:
So this year you get an extra $1.10 in interest, which is equal to your interest on last year’s
$10.50 worth of interest. That’s where the expression “interest on interest” comes from. So now
your account is worth your initial investment of $100, plus year 1’s total interest of $10.50, plus
year 2’s total interest of $11.60, which adds up to $122.10.
Year 3: