The Compound Interest of Everything

July 26, 2021

The law of compound interest is everywhere.

If you invest deeply in your relationships, they will grow. If you take the time to care for your family in everyday ordinary ways, it can have a meaningful ripple effect upon future generations.

It works in business too. If you excel in your work with a few people, they tend to tell others, and eventually you may begin working with many, resulting in a flourishing business.

We can also see the negative results of compound interest. Addictions compound. For a while they can be manageable in day-to-day life and suddenly, if they are not moderated, they can become unmanageable, multiplying out of control. Eventually they can destroy your life and the lives of others.

Relationships, business, and addiction are living metaphors for how compound interest works in the investment world. Compound interest has been described as interest on interest. Investments that feature compound interest have the advantage of not only receiving interest on the original investment amount (what’s called principal) you started with, but receiving interest on the interest that has already been accumulating upon your principal amount.

For example, the effect of the compound interest of an 8% annual return on a $100,000 investment will double in 9 years to approximately $200,000. This compound doubling repeats in the same manner continuously. Therefore, by year 18 it will have doubled again to $400,000.

On the other hand, simple interest only features interest on principal. An 8% annual return on $100,000 per year is $8,000. Over a period of 18 years this equals $144,000 of simple interest. While your total money at the end of eighteen years in the above scenario of investing $100,000 will be $244,000 due to simple interest of 8%, the effect of 8% compound interest of $100,000 in the same time frame would be a whopping $400,000.

You might think, “What investment options feature compound interest?” Glad you asked. Here is a simple example (pun intended): while individual bonds or a CD at a local bank receive simple interest, setting your stocks or stock funds to reinvest dividends receive compound interest. As always, there are risk factors to discuss about which of these may be an appropriate investment for you, so if you are interested in learning more set up a meeting with us.

In the meantime, start investing in other important areas of your life and in time you just might see the positive benefits of compound interest doing its work in the real world.