Once upon a time, a white-haired old guy declared, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t…pays it.” That old guy was Albert Einstein and, like many of his theories, he was right.

You’re probably familiar with the term, but how much thought have you given to the actual concept of compounding interest? If your answer leans more toward “not a whole lot” than the alternative on the scale, it’s time we changed that.

So, what exactly is compounding interest? In simple terms, compound interest is the interest you earn on interest; the interest you’re paid is calculated on the principal plus the interest you accumulated over the previous periods.

For example, Monica and Chandler each decide to invest $1,000.00 in the same stock, which has a return of 16% in interest annually. Monica plans to re-invest the interest and add it to her initial investment. Chandler decides not to re-invest the interest; he’s going to withdraw the interest he’s earned every year instead. Who do you think will have the highest return on investment at the end of a 10-year period?

Let’s do the math:

Initial InvestmentInterest EarnedTotal Value
Monica1,000.003,900.944,900.94
Chandler1,000.001,722.722,722.72

As you can see, because Monica chose to make interest on top of her interest by re-investing it, she more than quadrupled her initial investment! On the other hand, by withdrawing the interest he earned instead of re-investing it, Chandler didn’t even triple his. Behold the magic of compound interest and delayed gratification! It’s a beautiful thing right?!

There are multiple benefits of compounding interest:

  1. Faster Growth
    Because you’re earning interest on your interest, the initial investment will multiply exponentially over its lifetime. Passive income at its finest!
  2. Self-Feeding
    Unlike that sourdough starter you have on your counter, your initial investment “feeds” itself without you having to think about it. By setting up the reinvestment of the interest, your initial investment gets regular feeding allowing it to grow even faster than it would have if you just left it alone. Remember, the more you feed it, the more it will grow. If you can, choose shorter compounding intervals (daily is the best).
  3. Longer Terms Mean Higher Returns
    This point needs no explanation; the longer you leave it to do its thing the higher your return on investment will be.
  4. It’s Not Rocket Science
    You don’t need to break into NASA to steal any secret codes or have your PhD in Finance to see results. By doing a small amount of research (invest in what you love and believe in) and cultivating some patience, you too can have the same luck as the wealthiest 1% in the world. It’s the great equalizer.

So, what’s the catch, right? Well, to take full advantage of compounding interest you need the luxury of one thing. Time. Your investment will only yield these results if you let it work its magic. The key is to be consistent and disciplined. Try not to withdraw your profits till the end of your investment period and, as always, the best start is an early one. At the risk of sounding repetitive here, the longer you leave it, the more you will benefit.

We each have a unique and personal relationship with our money – it’s akin to finding the right balance in a partner for a flourishing long-term relationship. This is, after all, one of the most important relationships you will have in your life. Treat it as such. Give it the time and attention it needs. Start Early, be patient, and find what’s right for you.

To learn more, or if you have any questions, please contact Melanie Gauntlett, Financial Pensions Advisor at Freisenbruch, at mgauntlett@fmgroup.bm, or call +1 441 294 4660 Ext 279.