min read
· Posted on
September 2, 2021

What’s compound interest?

Compound interest def came up in high school math. But when it comes to investing, compound interest is key.

What's the key learning?

  • Compound interest is essentially interest on interest
  • It’s the interest earned on your initial investment, and then interest you earn on that investment
  • The interest compounds until you pull your investment out

We all have a vague memory of compound interest from our high school math days. But when it comes to investing, compound interest is key

And as Albert Einstein said “compound interest He who understands it, earns it … he who doesn't … pays it”

Compound interest is the interest received on your initial investment - as well as the interest you’ve earned on that investment. And the interest you receive on that investment. It’s essentially interest on interest. Or as we like to call it, interest inception.

Let’s run the numbers

  • You make a $10,000 investment which earns 7% return each year
  • After the first year, your investment is now worth $10,700 (the value of your initial investment, plus 7%)
  • After the second year, your investment - which is now $10,700 - earns 7% again
  • Fast forward, 40 years (without ANY additional investment) and all of a sudden your $10,000 has turned into nearly $150,000.

And this process will continue (i.e. compounds) until you pull your investment out. 

Gimme the math formula, Flux

If you want to do your own calculations, the formula for compound interest is FV = IV(1+r/n)ⁿᵗ, where:

  • FV = Final value
  • IV = Initial investment
  • r = the annual interest rate, written as a decimal (i.e. 5% = 0.05)
  • n = the number of times the interest compounds each year 
  • t = the total number of years you are investing for.

But there are tonnes of online calculators available so you can figure it out. The Government’s MoneySmart website has its own you can check out for free.

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