The Eighth Wonder of the WorldSubmitted by Fountain Financial Associates | Financial Advisors on May 25th, 2018
Posted on May 25, 2018 by Brice Gibson
As an advisor, I get to see all aspects of investing. There are many variables that generate great returns over time, but maybe the most powerful force in investing are two words “compound interest.” As a numbers person, the power of compounding interest is incredible to me. Albert Einstein once said “Compound interest is the 8th wonder of the world. He who understands it, earns it…he who doesn't…pays it.”
Einstein’s quote comparing compound interest to the 8th wonder of the world is a bold comparison, but it is one of the reasons many investors are so successful. So how does it work? You would think that compounding interest must be very complicated, but it’s quite simple. Compounding interest makes “interest on interest.” It is the addition of interest to the original principal that is then reinvested instead of being paid out. Interest reinvested grows at a much faster rate than simple interest, since you now have more money earning more interest. Most great forces in our world start very small. Think of compounding interest as a snowball. A snowball starts as a snowflake. Once it can roll down a hill, it will naturally do the work for you becoming a bigger and bigger unstoppable force. Compounding interest utilizes momentum.
Building wealth works very similarly to the way a snowball forms. It is usually tough and slow to accumulate in the beginning, but once you build your snowball, it attracts more wealth naturally. It takes time. Very few get rich overnight. Time is your most significant ally and the best way to maximize compounding, so start soon. Warren Buffet once quoted “I always knew that I was going to be rich, so I was never in a hurry to.”
As we celebrate 20 years as a firm, this chart illustrates 20 years of compounding if you were one of our first clients in 1998 and put compounding interest to work for you. The bar chart assumes that you made a one-time investment of $100,000 in 1998 and got an 8% return every year for the next 20 years. If you didn't make any withdrawals over this period, your initial $100,000 investment would be worth $466,095. The actual average return of the S&P 500 from 1998-2017 was 8.81% so you would actually have done even better if you had used the higher return. Your investment would have more than quadrupled in 20 years, all while going through the Tech Bubble bursting and the Great Recession. The chart also illustrates what the next 20 years would look like if you continued to earn 8% on the $100,000 investment. After 40 years the value would be $2,172,452. The longer you let compounding interest work for you, the better it gets.
Compounding interest is a remarkable force and your friend as an investor. Its simplicity may help make average people millionaires. It doesn't discriminate. Take advantage of this force. The financial habits that you put into place define your wealth. The choice is yours, you can put the power of compounding interest to work for you to build wealth, or you can let interest work against you and always fight it. I don’t know about you, but I would rather roll down a hill building wealth as I go, then fight my way uphill climbing to the top for lower returns. Take the 8th wonder of the world and do something great with it to help yourself, your family, and have a better life. It starts with you.