The Path to an Early Retirement
One dollar is not really one dollar. It would serve you well to begin viewing money in this way. Compound interest, for most, will be the path of least resistance to an early retirement. For the sake of comparison we’ll start with a basic example of simple (as opposed to compound) interest.
Simple Interest
You start off with $1,000 to invest. For simplicity we’ll say you are able to earn 10% a year on your initial investment. According to my calculator you would earn $100 that first year – along with every year after that. Your $1,000 doubles (to $2,000) in 10 years, triples in 20, and so on. Not bad, but, as we’ll see, a little boring.
Compound Interest
Same deal – we start out with $1,000. A year in and we compound at 10%, we make $100, and same as before we’re left with $1,100 at the end of year one. This is where the fun starts.
Our interest is going to continue compound at 10% – that part doesn’t change. The difference is, we are now able to multiply using previously accumulated interest. For year two we will make: $1100 * .1 = $110. Not yet a massive change, but at the end of 10 years this time, we find ourselves with $2,593.74. An increase of 159%! This is, of course, a significant improvement from the 100% increase we saw with simple interest. Let’s use a chart to take a closer look at how this works.
Compound Interest Chart
| 5% | 8% | 10% | |
|---|---|---|---|
| 10 Years | $1,628.89 | $2,158.92 | $2,593.74 |
| 20 Years | $2,653.30 | $4,660.96 | $6,727.50 |
| 30 Years | $4,321.94 | $10,062.66 | $17,449.40 |
| 40 Years | $7,039.99 | $21,724.52 | $45,259.26 |
The Formula Behind it All
For those who are interested we’ll take a more granular peek at what’s going on here. The formula for compound interest is as follows:
We have a couple variables to run through here:
- A – Total amount after the principal investment has finished compounding.
- P – The amount of the principal investment
- r – the interest rate being paid
- n – amount of times per period that interest is applied
- t – time (the number of interest periods)
Conclusion
Remember how we said $1 isn’t really $1? Consider the stock market – the average annual return on the S&P 500 is about 8%. If we take a look back at our chart, and the performance values based on that 8% return rate, we find that $1 is really worth the following:
- After 10 years: $2.15
- After 20 years: $4.66
- After 30 years: $10.06
- After 40 years: $21.72
Try to consider that the next time you’re spending $20 on something you don’t need. You’re not just spending $20 – 40 years from now, that could’ve been $434.
