Stock Investing For Dummies - Compound Interest Made Simple

Impact of Compound Interest

Hi,

Today I will talk about one of my favorite topics, the compound interest. Even Albert Einstein has said that this is the 8^th wonder of the world! Albert was a very clever man and that’s the main reason why his quote about this topic can be found from my blog (and off course because the quote is true). The quote goes:

" Compound interest is the 8th wonder of the world. He who understand it, earns it... He who doesn't, pays it."

In theory, compound interest means “interest on interest” and this is calculated by multiplying the amount by one plus the annual interest rate raised to the number of compound periods minus one. Too scientific? No problem 😀 I will make an example.

Let’s think about a situation where “John” invest 1000 dollars to a stock. The stock pays dividend of 5% for the investment annually. So, let’s check what has happened to investment in 1, 5, 10 and 20 years. The value of the stock hasn’t changed during the years (yeah, I know, this will change (on an average of +7%) but not in this example, for the sake of learning 😀).

	once time investment	Compounding dividends	Without compounding	Compounding benefits	total amount compounded
year 1	1000	50	50	0 %	1050
year 5	1000	276,2815625	250	11 %	1276,281563
year 10	1000	628,8946268	500	26 %	1628,894627
year 20	1000	1653,297705	1000	65 %	2653,297705

Like you can see from the example above, the impact of compounding investment always needs to be done long-term, in this cases it means +10 years. The benefit of compounding increases when the investment time gets longer. 

Unfortunately, nobody didn’t teach me the compound effect 20 years ago, but this is something which I can teach to my kids and I can use this wisdom when I make investment plan for them and for myself.  

But hopefully this simple example gives you a understanding what compound interest is and how you can benefit from it. Please tell me if you want to see an example(s) where the stock growth, dividend re-investments, monthly purchases, etc. are included.  

Regards,

CVM