Once described by none other than Albert Einstein as the “Eighth wonder of the world”, (while still having a lot of uses outside of the financial field) compound interest is one of the key principles in investing.
But what is it? And how can we take advantage of it?
Imagine a waterfall falling on a big rock. Because of hundreds of years of water falling on the surface of the rock, it begins to erode over time. This is a key element in understanding compound interest: time.
Ok, now let’s look at another analogy, this time something more relatable. A lot of people nowadays have developed a habit of buying coffee every day from their favourite coffee shop. If a coffee costs them $5, over a month they spend around $150 just on coffee. Compound interest is when you do something regularly over a certain period of time.
Another example, this time applied in investing: how much money would you have if you invest $10 every month in a stock? If we just save that money, over 30 years, it will become $3600. However, if we invest it, and get an 8% profit every year, we will have $13,694.51. The most important element here is patience.
This happens because aside from the $10 contribution, we get an additional 8% per year. This can be seen in the graph at the beginning of the article.
Sources:
⁃ Wikipedia
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