This is 100% possible with the magic of compound interest and how if you start investing in almost ANY stocks early enough in life. Almost any stock with enough time will increase in value. It really does make the difference on your potential Return on Investment (ROI) between hundreds of thousands of dollars. Yes, that’s right, I said hundreds of thousands could be the difference when starting your investment plan early (in your 20s for example) versus even a little bit later (30s and 40s).
The difference is time, and when you are younger, time is heavily on your side for an investment to grow if and only if you can leave the investments alone. Let’s get back to compound interest and how it works and why it’s so important. The most important point to remember with compound interest is that the interest gained on the principle grows along with the original principle investment. As the amount compounds on itself, it will continue to grow for years at an accelerated rate due to the compound interest. Even Albert Einstein said compound interest is the most powerful force in the world, calling it the 8th wonder of the world. For example, if an investment of $100 earns $10 the first year, the next year the amount starts at $110 and keeps growing. Compound interest and the time value of money go hand in hand like peanut butter and jelly.
Time Value of Money
Let me further explain and give an example of compounding interest and the time value of money. Let’s begin by introducing two friends, Charlie & Larry. Charlie is a very attentive student about investing advice, and Larry tends to procrastinate concerning any advice of investing. Charlie quickly began to digest and understand the fundamentals of investing due to his research and of course, the simple concepts to investing.
Why is time so important?
When Charlie was 21, he took $1,000 and per his studies, he invested it into a broad index mutual fund and stayed to the principles learned and never sold the fund. The stock market averaged the same rate of return that it has since 1910 and grew at a 11% rate of return.
- After one year, Charlie’s investment grew by 11% and beginning in year two he was left with $1,110 (1000 x 1.11).
- After year two, the investment grew again by 11% to $1232.10 (1110 x 1.11)
- Year three it continued the growth giving him $1367.63 (1232.10 x 1.11)
- And year four it was $1518.07 (1367.63 x 1.11).
Wow, after just four years, the total return was $518.07 along with the $1000.00 in principle. In year seven, after the trend kept up, the original $1000.00 was now $2076.16. Charlie found it amazing that the money really did double in seven years. In 20 years, the original investment would eventually be worth $8062.31. In 40 years, it would be worth $65,000.87. This is the magic of compound interest on full display. It only worked for Charlie since he didn’t ever touch the original money and let it grow. What happened to Larry, though?
Larry eventually began to learn the concepts of investing, but he waited until he was 31, a good ten years behind Charlie. Larry thought he was always smarter than Charlie. He decided he would double the amount Charlie invested and put in $2,000 to start. Well, Larry had $5,678.84 in ten years from the original investment and thought he was doing great. Since he only had 30 years to let it grow as opposed to Charlie because he started later at age 31, his ending investment at the same age of 61 was $45,784.59.
Larry thought he was much smarter because he put in double the money than Charlie had originally invested. Larry’s confusion was that he ended up with less in the end. What happened here? Well, the answer is in the magic of time and compound interest. The extra ten years allowed Charlie’s smaller investment to grow at a much faster rate, while Larry kept waiting to get started with his personal investment plan. Years later, Larry went back to the same investment book and tried to find out what happened.
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Alex Richwagen is an investment research analyst. Any of his recommendations are that of Mr. Richwagen, the information presented by him is the opinion of his research. All investment decisions are your choice and should be based on your own analysis.