Okay, lets say I have $100 to save. If I put that in the bank and I am getting a 10% interest rate (for illustrative purposes), then I am going to receive $10 in interest at the end of the year. Simple enough right? Now lets say that instead of blowing that $10 on a drink at the pub; you leave it in the bank for another year. That means that the second year you'd have $110 at 10%; the interest on this amounts to $11. Notice how we got more interest there. Not much at the start but here's what happens if we leave that money in the bank for say 40 years:
Year 1 100
Year 2 110
Year 3 121
Year 4 133
Year 5 146
Year 6 161
Year 7 177
Year 8 195
Year 9 215
Year 10 237
Year 11 261
Year 12 287
Year 13 316
Year 14 348
Year 15 383
Year 16 421
Year 17 463
Year 18 509
Year 19 560
Year 20 616
Year 21 678
Year 22 746
Year 23 821
Year 24 903
Year 25 993
Year 26 1,092
Year 27 1,201
Year 28 1,321
Year 29 1,453
Year 30 1,598
Year 31 1,758
Year 32 1,934
Year 33 2,127
Year 34 2,340
Year 35 2,574
Year 36 2,831
Year 37 3,114
Year 38 3,425
Year 39 3,768
Year 40 4,145
So we managed to turn a $100 into $4,145 over 40 years. And here's the kicker, we didn't do anything to earn that money! We didn't work for it, all we did was leave it in the bank and not spend it.
Do you get the picture yet? Now try an imagine, instead of $100, we had $1,000. Or maybe we put in $100 a month. You can see how it would add up over the course of your life. You see, compound interest is just like a snowball rolling down a mountain. It may start out small, but the further it rolls the more snow it collects, as it gets bigger, it collects even more snow than it did before.
It seems like such a simple concept, and most of you will say, "Well, duh! I understand how compound interest works!" But I you wont truly understand how powerful a concept it is until you've studied it some more and tried it out for your self.
Recommended Reading:
The Richest Man in Babylon
How Math Can Save Your Life: (And Make You Rich, Help You Find The One, and Avert Catastrophes)
