FAMILY & HOME
The Power of
Compound Interest
By Donald Broughton
W
What does the flip side look like? Warren Buffet’s company, Berkshire
hy should you pay off your credit cards? Why
Hathaway, has produced an annualized compound growth rate of just
should you spend an extra couple of hours
under 20 percent since 1967. Net result, Buffet, despite not coming from
this week learning a new skill? Exercising?
inherited wealth, is the third-richest man in the world, has often been
Working? Insisting your investments generate
ranked as the richest, and is worth more than $70 billion.
a slightly larger rate of return?
In her song, “Material Girl,” Madonna crooned, “Some boys romance,
Everyone has heard about it. Everyone from Madonna to Albert
some boys slow dance, that’s all right with me. If they can’t raise my
Einstein has commented on it, but unfortunately, so very few understand
interest then I have to let them be.” She understood compound interest,
how powerful a force it is, or how broadly it applies to our lives. What is
but what she might not have understood that Einstein did, is that
it? Compound interest.
compound interest is a force of nature. The eighth wonder of the world
What is compound interest? Wikipedia defines it as “interest added
applies to everything.
to the principal of a deposit or loan so that the added interest also earns
If I invest 10 percent more time working at becoming a better writer,
interest from then on.” This adding of interest to the principal is called
investor, bicyclist, gardener, lover, salesman, carpenter,
compounding. A bank account, for example, may have
or even basket weaver, over a lifetime I’ll become a six-
its interest compounded every year. In this case, an
“COMPOUND INTEREST
fold better writer, investor, bicyclist, gardener, lover,
account with $1,000 initial principal and 20 percent
IS THE EIGHTH WONDER
salesman, carpenter or basket weaver than I would
interest per year would have a balance of $1,200 at the
OF THE WORLD.
have been otherwise. If I invest 20 percent more time
end of the first year, $1,440 at the end of the second
HE WHO UNDERSTANDS
working at something, then I become the Buffet,
year, $1,728 at the end of the third year, and so on. In
IT, EARNS IT. HE WHO
Shakespeare, Armstrong, Casanova, basket weaver,
simple terms, it’s the interest earning interest on the
DOESN’T, PAYS IT.”-
aka Thomas Jefferson.
previous interest earned.
ALBERT EINSTEIN
What’s my point? No matter who you are,
Almost any investment advisor can tell you about
where you are in life or how old you are, stop and consider the power
the power of compound interest and how over long periods of time, its
of compound interest. What do you wish you could do better? What
power is magnified. If $10,000 is invested at a 5 percent rate of interest
do you wish you had more of? Starting today, invest more time into that
with no additional money invested, it becomes $70,400 over a 40-year-
endeavor. Do so again tomorrow and the next day. Results never come as
period. Simply doubling the rate of return to 10 percent turns $10,000
quickly as we’d like with any worthy endeavor, but if you invest 20 percent
into $452,593 over a 40-year-period. Doubling the interest rate earned
more into that effort, several years from now, the power of compounding
results of a more than six-fold increase in total return as the power of
interest will take over, and you will enjoy a bounty. Over time, you will be
interest compounding on interest takes over. But that is child’s play.
earning it instead of paying it.
Let’s double the interest rate again - this time from 10 percent to 20
percent. If $10,000 is invested at a 20 percent rate of interest with no
As founder and managing partner at Broughton
additional money invested, it becomes $14,697,716! Doubling the interest
Capital, Broughton is a frequent guest on CNBC,
rate to 20 percent results in a more than 32-fold increase over 10 percent,
“Nightly Business Report” and Fox. He is regularly
and a 208-fold increase over 5 percent.
quoted in The Wall Street Journal, where he is
Think about this the next time you consider not paying off your credit
also recognized as a top stock picker, along with
cards in full every month, most of which charge an interest rate of about
“Fortune,” “Zacks” and “StarMine.”
20 percent. If you carry a balance, you are living out Einstein’s warning and
making the credit card company rich, while guaranteeing your own poverty.
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