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The Power of Compound Interest
Teaching English - Talking Business. Every Monday, Wednesday & Friday.
Iain Shirlaw
June 14, 2024
Welcome to Finance Friday.
When is the best time to start investing? When you are born, if your parents have foresight and enough money to invest some money for you. If not, then when you start having money of your own - for example when you start working. And if you are reading this and have not started investing yet then the best time is now!
Please note that I do not recommend investing if you have high-interest loans. Most loans, apart from a mortgage (a loan for property), fall into this category. In addition, I believe that everyone should have an emergency fund equivalent to 3 to 6 months salary.
Nothing in this newsletter is financial advice. These are my ideas for educational purposes only. Always speak to a financial advisor. Remember that I do not know, nor want to know, your personal financial circumstances.
In this newsletter, I want to examine why it is so important to start investing as soon as possible.
The Power of Compound Interest
Imagine that you have an investment that pays 10% interest a year. You invest 1,000$. This is your ‘principal’ amount. How much do you have at the end of the first year?
1,000 + (1,000 × 0.1) = 1,100$. You have gained 100$ over the year.
How much do you have at the end of the second year if you do not withdraw the interest?
1,100 + (1,100 × 0.1) = 1,210$. This year you have gained not just 100$ but 110$ over the year.
This is compound interest or compounding in action.
Compounding is the process whereby interest is credited to an existing principal amount as well as to interest already paid.
Compound Interest - Examples
All these examples assume investing in a fund tracking an index and returning an average of 8% per year. All the people want to retire at age 65.
Julie finished university and started working at age 25. She invested a 1,000$ graduation present. At age 65 (40 years compounded), Julie has 21,725$.
David’s parents invested 1,000$ when he was born. At age 65 (65 years compounded), David has 148,780$.
Mary also finished university and started working at age 25. She also invested a 1,000$ graduation present but she also decided to invest 1000$ a year for her working length until she was 65. At age 65, Mary has 301,506$.
Michael’s parents also invested 1,000$ when he was born. His parents also invested 1,000$ a year until he was
25. From the age of 25, Michael started working and also invested 1,000$ a year. At age 65, Michael has 2,143,808$
Heather started working at age 25. She did not have a principal to invest but she invested 200$ a month for her working life until she retired at 65. At age 65, Heather has 711,069$.
These examples show the power of investing as much as you can, as soon as you can.
Words of the Day: Principal and Interest
Principal (money) - noun - an amount of money that someone has invested in a bank or lent to an individual or company in order to receive interest on it.
“I only ever withdraw interest from my account. I never withdraw the principal.”
Interest (money) - noun - money that you earn by keeping your money in an account in a bank or other financial institution.
“My bank pays 2% interest on deposits.”
Interest (money) - noun - money that is charged by a bank or other financial institution for borrowing money.
“My bank charges 4% interest on loans.”
Do you have any Business English questions?
Please email me and I will do my best to answer them in future newsletters.
Until Monday - have a great weekend!
Iain.
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