A simple example of the power of compound interest

There is an urban myth that Albert Einstein, when asked what the most powerful invention by man was, simply replied with “compound interest”. While there is little proof that Einstein actually said that, I believe it isn’t unlikely that the man who helped invent the atomic bomb would recognise compound interest as an incredibly powerful concept.

What makes compound interest so amazing are the seemingly impossible amounts that money can grow to if left for a long enough time. While it is difficult to conceptualise how huge amounts can accumulate to under compound interest, I came across an example the other day that really helps put it into perspective.

Imagine a worm one centimetre long – so not that much bigger than a grain of rice. Every day, this worm grows ten percent longer. So on day one it is one centimetre long. On day two it is 1.1 centimetres long, on day three 1.21 centimetres long etc.

How long will the worm be after one year?

Now, you would have gathered that the answer to this question is going to be a big number. So, how big do you think it will grow? A kilometre? Ten kilometres? Or something audacious like the distance from Durban to Johannesburg?

A one centimetre long worm that grows ten percent longer every day, will stretch from the sun, to Pluto, back to the sun and end on Venus after a year of growing at that rate.

Absolutely mind-boggling, I know. Even after checking this myself it still feels impossible. But far from being just an interesting anecdote, this example does illustrate a very important aspect of compound interest that you can use to your advantage:

Invest early, and invest for a long time.

Compound interest means that your money grows exponentially. In our example above, after eleven months our worm only stretches 12% of the way from the sun to Pluto. The last month of the worm’s growth makes up 94% of its total growth after a year.

What does that mean for you now? It means that it is never too early to start saving. Are you thinking of only starting to save in two years’ time once you have a better cashflow situation? Don’t wait too long – every year you wait now has a massive impact once you want to realise your investment!Image

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3 thoughts on “A simple example of the power of compound interest

  1. Hi.

    I’ve just met you and already I like you! 🙂

    I just love the way you explained probably one of the most overlooked, yet powerful concepts ever.
    As a financial advisor, myself, I can say with a fair amount of certainty that if more people considered the power of compound interest in the way you explain it, there would be a whole lot more serious saving going on… and it’s not like we can do without that.

    Regards

    Rafieq

  2. Pingback: The three biggest financial mistakes that I made in my twenties – The Opinionated Actuary

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