DISCLAIMER: I am not a financial advisor and this should not be taken to be financial advice. You should consult a financial professional for advice. I am a financial amateur. These are my thoughts and opinions on money that I have recorded here for my children, with the hope that my thoughts might help them. They are responsible for the results of the advice they choose to follow. Always worth keeping in mind: Past performance is no guarantee of future results. Your mileage may vary. The map is not the territory. Keep your eyes open. Smell it before you take a bite.
To my children:
Compound interest is your new best friend if you’ve never heard of it. It’s the magical situation of your money working for you AND also the money that your money made is working for you. Let me give you an example. There is linear growth and exponential growth. Say you have $100 to invest. A linear growth option is if someone says, “If you invest your $100 with me, then I’ll give you $10 every year.” So after 1 year, you’d have $110, after 2 years, you’d have $120, and after 3 years, you’d have $130. An offer of exponential growth is if someone says, “If you invest your $100 with me, then I’ll give you 10% every year.” So after 1 year, you’d have $110 ($100 x 1.1), after 2 years, you’d have $121 ($110 x 1.1), and after 3 years, you’d have $133.10 ($121 x 1.1). This is a better option. This is the magic of compound interest. The interest that you made on your investment gets to grow too, not just your original $100. After 10 years, your $100 becomes $259.37 ($100 x 1.1^10) with exponential growth of compound interest, while it would have been only $200 ($100 + ($10 x 10)) with the linear growth investment option.
To get you more excited, here’s a chart that shows how much a $1,000 investment would be after 10, 20, 30, and 40 years.
So, what to do with all this information? There aren’t linear growth investment options vs exponential ones, they are mostly all exponential ones, which is great news. The reason that it’s worth knowing about compound interest and how exponential growth works is so that you know that, after a while, the percentages and years and dollars add up.
It’s hard to look at a seed and see a tree. But try. Because $1,000 becomes $6,727 after 20 years of 10% growth. And $1,000 becomes $45,259 after 40 years of 10% growth. ($1,000*1.1^20 = $6,727, $1,000*1.1^40 = $45,259) And investing in index funds is like planting a tree. You can invest, walk away for 20 years, and come back to a money tree, sit in the shade and eat what will taste like a free apple.
And, if you haven’t started saving yet, just remember the Chinese proverb: “The best time to plant a tree was 20 years ago. The second best time is now.”
Bottom Line: Invest as much as you can as early as you can to enjoy the fruits of the magic of compound interest, which is your money working for you and your money’s money working for you. All while you do other things.