Home » How the Rich get Richer - the Secret of Compound Interest

How the Rich get Richer - the Secret of Compound Interest

Posted: Sunday, April 03, 2011

by Jamie Alexander
http://www.inspiredtosave.com

If you have ever wondered why the rich always get richer the reasons may surprise you. It often comes down to two things.

They spend less than they earn
They earn interest on top of interest (compound interest)

The first reason is quite obvious. If they spend less than they earn then they will always have more money. Hence, they will always get richer.

The second reason more or less turbo charges the first reason. Say for instance you have $10,000 in an investment account. If that account has an interest rate of 10% then after one year you will have $11,000. If you don’t spend any of that money after two years you would expect to have $12,000 after the interest is applied. However, you will actually end up with $12,100.

This is because you have earned interest on top of interest. I.e. the 10% interest was actually applied to the $11,000. This is an example of Compound Interest.

Now I bet you are thinking ‘so what. I only earned $100 more than I expected'. And that is correct, but what you need to consider is the long term effects of that extra money being compounded.

The figures below show what would happen to that $10,000 if it was invested for different lengths of time at a 10% interest rate.

10 years = $25,937
25 years = $108,347
50 years = $1,173,909
100 years = $137,806,123

As you can see the amounts of money increase by a staggering amount over time. However, realistically, you are unlikely to invest your money for 50 or 100 years unless you particularly keen on your descendents.

If however you were spending less than you earn and you also invested say $500 per month on top of that original one off $10,000 investment, your money would grow as follows.

10 years = $126,742
25 years = $730,393
50 years = $8,535,637
100 years = $1,009,366,604

You are reading that correctly. After 50 years you would have over 8 million dollars, and after 100 years you would have over one billion dollars! This is not a trick. The maths is accurate.

What is even more amazing is the huge effects a few small changes can have can have on the outcome e.g. If we use a 12% interest rate as opposed to a 10% interest rate in the example above, the numbers would grow as follows:

After 10 years = $143,195 - this is 13% more than before ($126,742)
After 25 years = $1,022,004 - this is 40% more than before ($730,393)
After 50 years = $18,226,138 - this is 114% more than before ($8,535,637)
After 100 years = $5,282,730,057 - this is 423% more than before ($1,009,366,604)

Now as you can imagine, if you are wealthy, investing $10,000 and then adding an additional $500 dollars to the account each month would probably not be very difficult. In fact many people may invest even more. This is why they get so rich.

I bet you're now thinking, 'I wish I was rich, so that I could take advantage of it'. The good news is you don't have to be rich to benefit from compound interest. You could potentially gain from it by investing any amount you feel comfortable with. Try this for yourself on a Compound Interest Calculator.

Jamie Alexander has a First Class Degree in Economics and is passionate about the benefits of long-term investing. Visit his Compound Interest Calculator today.

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