The Magic of Compound Interest

Ric Werme's Finances for Young Adults
The Magic of Compound Interest

Imagine you're in a car accelerating onto the freeway. The car's acceleration pushes you back in the seat, but as the car shifts to higher gears, the acceleration lets up and you wind up cruising at the speed limit. Suppose instead that the acceleration stays steady and every second you speed up 3 miles per hour. If you start accelerating from 30 mph on the ramp, then in 10 seconds you'll pass 33, 36, 39, 42, 45, 48, 51, 54, 57, and 60. In another 10 seconds you'll be at 90, barring some common sense.

Instead of that steady acceleration, suppose you increased your velocity about 7% every second. From 30, you'd reach 32.2, 34.5, 37.0, 39.6, 42.4, 45.5, 48.8, 52.2, 56.0, 60.0. While initial push back in your seat is less than in the first case, by the time you hit 60 you'll be pushed back with twice the force. In another 10 seconds, the force will double again and you'll be at 120 mph. Cool!

That's exactly what compound interest does to your savings. The time scale is longer, it takes more than 10 years at a 7% interest rate to double your money, but at least there's no speed limit. Here's a table showing what $1,000 can become just by compound interest.

One-time $1,000 investment

Rates

Year 1% 3% 5% 10% 15% 20% 21%

0 $1,000.00 $1,000.00 $1,000.00 $1,000.00 $1,000.00 $1,000.00 $1,000.00

1 $1,010.00 $1,030.00 $1,050.00 $1,100.00 $1,150.00 $1,200.00 $1,210.00

2 $1,020.10 $1,060.90 $1,102.50 $1,210.00 $1,322.50 $1,440.00 $1,464.10

3 $1,030.30 $1,092.73 $1,157.63 $1,331.00 $1,520.88 $1,728.00 $1,771.56

4 $1,040.60 $1,125.51 $1,215.51 $1,464.10 $1,749.01 $2,073.60 $2,143.59

5 $1,051.01 $1,159.27 $1,276.28 $1,610.51 $2,011.36 $2,488.32 $2,593.74

6 $1,061.52 $1,194.05 $1,340.10 $1,771.56 $2,313.06 $2,985.98 $3,138.43

7 $1,072.14 $1,229.87 $1,407.10 $1,948.72 $2,660.02 $3,583.18 $3,797.50

8 $1,082.86 $1,266.77 $1,477.46 $2,143.59 $3,059.02 $4,299.82 $4,594.97

9 $1,093.69 $1,304.77 $1,551.33 $2,357.95 $3,517.88 $5,159.78 $5,559.92

10 $1,104.62 $1,343.92 $1,628.89 $2,593.74 $4,045.56 $6,191.74 $6,727.50

11 $1,115.67 $1,384.23 $1,710.34 $2,853.12 $4,652.39 $7,430.08 $8,140.27

12 $1,126.83 $1,425.76 $1,795.86 $3,138.43 $5,350.25 $8,916.10 $9,849.73

13 $1,138.09 $1,468.53 $1,885.65 $3,452.27 $6,152.79 $10,699.32 $11,918.18

14 $1,149.47 $1,512.59 $1,979.93 $3,797.50 $7,075.71 $12,839.18 $14,420.99

15 $1,160.97 $1,557.97 $2,078.93 $4,177.25 $8,137.06 $15,407.02 $17,449.40

16 $1,172.58 $1,604.71 $2,182.87 $4,594.97 $9,357.62 $18,488.43 $21,113.78

17 $1,184.30 $1,652.85 $2,292.02 $5,054.47 $10,761.26 $22,186.11 $25,547.67

18 $1,196.15 $1,702.43 $2,406.62 $5,559.92 $12,375.45 $26,623.33 $30,912.68

19 $1,208.11 $1,753.51 $2,526.95 $6,115.91 $14,231.77 $31,948.00 $37,404.34

20 $1,220.19 $1,806.11 $2,653.30 $6,727.50 $16,366.54 $38,337.60 $45,259.26

21 $1,232.39 $1,860.29 $2,785.96 $7,400.25 $18,821.52 $46,005.12 $54,763.70

22 $1,244.72 $1,916.10 $2,925.26 $8,140.27 $21,644.75 $55,206.14 $66,264.08

23 $1,257.16 $1,973.59 $3,071.52 $8,954.30 $24,891.46 $66,247.37 $80,179.53

24 $1,269.73 $2,032.79 $3,225.10 $9,849.73 $28,625.18 $79,496.85 $97,017.23

25 $1,282.43 $2,093.78 $3,386.35 $10,834.71 $32,918.95 $95,396.22 $117,390.85

26 $1,295.26 $2,156.59 $3,555.67 $11,918.18 $37,856.80 $114,475.46 $142,042.93

27 $1,308.21 $2,221.29 $3,733.46 $13,109.99 $43,535.31 $137,370.55 $171,871.95

28 $1,321.29 $2,287.93 $3,920.13 $14,420.99 $50,065.61 $164,844.66 $207,965.06

29 $1,334.50 $2,356.57 $4,116.14 $15,863.09 $57,575.45 $197,813.59 $251,637.72

30 $1,347.85 $2,427.26 $4,321.94 $17,449.40 $66,211.77 $237,376.31 $304,481.64

One-time $1,000 investment
	Rates
Year	1%	3%	5%	10%	15%	20%	21%
0	$1,000.00	$1,000.00	$1,000.00	$1,000.00	$1,000.00	$1,000.00	$1,000.00
1	$1,010.00	$1,030.00	$1,050.00	$1,100.00	$1,150.00	$1,200.00	$1,210.00
2	$1,020.10	$1,060.90	$1,102.50	$1,210.00	$1,322.50	$1,440.00	$1,464.10
3	$1,030.30	$1,092.73	$1,157.63	$1,331.00	$1,520.88	$1,728.00	$1,771.56
4	$1,040.60	$1,125.51	$1,215.51	$1,464.10	$1,749.01	$2,073.60	$2,143.59
5	$1,051.01	$1,159.27	$1,276.28	$1,610.51	$2,011.36	$2,488.32	$2,593.74
6	$1,061.52	$1,194.05	$1,340.10	$1,771.56	$2,313.06	$2,985.98	$3,138.43
7	$1,072.14	$1,229.87	$1,407.10	$1,948.72	$2,660.02	$3,583.18	$3,797.50
8	$1,082.86	$1,266.77	$1,477.46	$2,143.59	$3,059.02	$4,299.82	$4,594.97
9	$1,093.69	$1,304.77	$1,551.33	$2,357.95	$3,517.88	$5,159.78	$5,559.92
10	$1,104.62	$1,343.92	$1,628.89	$2,593.74	$4,045.56	$6,191.74	$6,727.50
11	$1,115.67	$1,384.23	$1,710.34	$2,853.12	$4,652.39	$7,430.08	$8,140.27
12	$1,126.83	$1,425.76	$1,795.86	$3,138.43	$5,350.25	$8,916.10	$9,849.73
13	$1,138.09	$1,468.53	$1,885.65	$3,452.27	$6,152.79	$10,699.32	$11,918.18
14	$1,149.47	$1,512.59	$1,979.93	$3,797.50	$7,075.71	$12,839.18	$14,420.99
15	$1,160.97	$1,557.97	$2,078.93	$4,177.25	$8,137.06	$15,407.02	$17,449.40
16	$1,172.58	$1,604.71	$2,182.87	$4,594.97	$9,357.62	$18,488.43	$21,113.78
17	$1,184.30	$1,652.85	$2,292.02	$5,054.47	$10,761.26	$22,186.11	$25,547.67
18	$1,196.15	$1,702.43	$2,406.62	$5,559.92	$12,375.45	$26,623.33	$30,912.68
19	$1,208.11	$1,753.51	$2,526.95	$6,115.91	$14,231.77	$31,948.00	$37,404.34
20	$1,220.19	$1,806.11	$2,653.30	$6,727.50	$16,366.54	$38,337.60	$45,259.26
21	$1,232.39	$1,860.29	$2,785.96	$7,400.25	$18,821.52	$46,005.12	$54,763.70
22	$1,244.72	$1,916.10	$2,925.26	$8,140.27	$21,644.75	$55,206.14	$66,264.08
23	$1,257.16	$1,973.59	$3,071.52	$8,954.30	$24,891.46	$66,247.37	$80,179.53
24	$1,269.73	$2,032.79	$3,225.10	$9,849.73	$28,625.18	$79,496.85	$97,017.23
25	$1,282.43	$2,093.78	$3,386.35	$10,834.71	$32,918.95	$95,396.22	$117,390.85
26	$1,295.26	$2,156.59	$3,555.67	$11,918.18	$37,856.80	$114,475.46	$142,042.93
27	$1,308.21	$2,221.29	$3,733.46	$13,109.99	$43,535.31	$137,370.55	$171,871.95
28	$1,321.29	$2,287.93	$3,920.13	$14,420.99	$50,065.61	$164,844.66	$207,965.06
29	$1,334.50	$2,356.57	$4,116.14	$15,863.09	$57,575.45	$197,813.59	$251,637.72
30	$1,347.85	$2,427.26	$4,321.94	$17,449.40	$66,211.77	$237,376.31	$304,481.64

There's a lot of important information in this table, there's a lot to learn to use it well. Various notes:

A 10% rate is 10 times better than a 1% rate - not!
Well, it is for one year. In the second year, you earn $110.00 vs. $10.10. That's still not much of a deal. After 7 years, the 10% return has nearly doubled your money (a 95% total return) and the 1% rate is only a 7.2% total return. It will take the 1% rate over 70 years to double that $1,000. By then the 10% return will have doubled your $1,000 10 times, that's a cool million bucks.
Time is your friend.
The longer you can invest, the more big income years you'll have. We'll get back to this in another page.
High interest rates are good.
There's just one catch, the higher the rate, the higher the risk. Therefore, a corollary: Risk is good. However, keep the seatbelt fastened. There are ways you can invest $1,000 that really risk $10,000. That's too much risk for me!
Really high interest rates are magic.
Did you notice the rates at the top of the columns? The last two columns are 20% and 21%. Look at the 30 year returns for those rates. Notice that if you invested $1,000 at 1% and $1,000 at 20% you would still wind up with less than $1,000 at 21%. Even $1,000 in both 10% and 11% rates lag far, far, behind.
Don't expect to get those rates! They are fun to dream about, though.
Can I become a bank and issue credit cards? Dream on!
Hmm, department stores often charge more than 20% for credit card debt. No wonder they're so interested in getting you to use their cards. Of course, to lend money to people, you need to offer checking and savings accounts to have money to lend. Citizens Bank offers a checking account at 0.10% interest and a savings account at 1.00% interest. Their Circle Rewards Platinum MasterCard has rates up to 16.99%, at least that's better than department store cards.
In the last decade or so, banks have really gotten obnoxious about all the little things they charge for and make a profit at. All in all, I have more respect for oil companies.

Instead of a one-time investment of $1,000, investing $1,000 each year is more than twice as good. You can take the table above and add up everything in each column to see what happens - investing $1,000 each year for five years leaves you with $1,000 invested for 5 years, $1,000 invested for 4 years, etc. Or you can just see the results in this table:

$1,000 invested each year

Rates

Year 1% 3% 5% 10% 15% 20% 21%

0 $1,000.00 $1,000.00 $1,000.00 $1,000.00 $1,000.00 $1,000.00 $1,000.00

1 $2,010.00 $2,030.00 $2,050.00 $2,100.00 $2,150.00 $2,200.00 $2,210.00

2 $3,030.10 $3,090.90 $3,152.50 $3,310.00 $3,472.50 $3,640.00 $3,674.10

3 $4,060.40 $4,183.63 $4,310.13 $4,641.00 $4,993.38 $5,368.00 $5,445.66

4 $5,101.01 $5,309.14 $5,525.63 $6,105.10 $6,742.38 $7,441.60 $7,589.25

5 $6,152.02 $6,468.41 $6,801.91 $7,715.61 $8,753.74 $9,929.92 $10,182.99

6 $7,213.54 $7,662.46 $8,142.01 $9,487.17 $11,066.80 $12,915.90 $13,321.42

7 $8,285.67 $8,892.34 $9,549.11 $11,435.89 $13,726.82 $16,499.08 $17,118.92

8 $9,368.53 $10,159.11 $11,026.56 $13,579.48 $16,785.84 $20,798.90 $21,713.89

9 $10,462.21 $11,463.88 $12,577.89 $15,937.42 $20,303.72 $25,958.68 $27,273.81

10 $11,566.83 $12,807.80 $14,206.79 $18,531.17 $24,349.28 $32,150.42 $34,001.31

11 $12,682.50 $14,192.03 $15,917.13 $21,384.28 $29,001.67 $39,580.50 $42,141.58

12 $13,809.33 $15,617.79 $17,712.98 $24,522.71 $34,351.92 $48,496.60 $51,991.32

13 $14,947.42 $17,086.32 $19,598.63 $27,974.98 $40,504.71 $59,195.92 $63,909.49

14 $16,096.90 $18,598.91 $21,578.56 $31,772.48 $47,580.41 $72,035.11 $78,330.49

15 $17,257.86 $20,156.88 $23,657.49 $35,949.73 $55,717.47 $87,442.13 $95,779.89

16 $18,430.44 $21,761.59 $25,840.37 $40,544.70 $65,075.09 $105,930.56 $116,893.67

17 $19,614.75 $23,414.44 $28,132.38 $45,599.17 $75,836.36 $128,116.67 $142,441.34

18 $20,810.90 $25,116.87 $30,539.00 $51,159.09 $88,211.81 $154,740.00 $173,354.02

19 $22,019.00 $26,870.37 $33,065.95 $57,275.00 $102,443.58 $186,688.00 $210,758.36

20 $23,239.19 $28,676.49 $35,719.25 $64,002.50 $118,810.12 $225,025.60 $256,017.62

21 $24,471.59 $30,536.78 $38,505.21 $71,402.75 $137,631.64 $271,030.72 $310,781.31

22 $25,716.30 $32,452.88 $41,430.48 $79,543.02 $159,276.38 $326,236.86 $377,045.39

23 $26,973.46 $34,426.47 $44,502.00 $88,497.33 $184,167.84 $392,484.24 $457,224.92

24 $28,243.20 $36,459.26 $47,727.10 $98,347.06 $212,793.02 $471,981.08 $554,242.16

25 $29,525.63 $38,553.04 $51,113.45 $109,181.77 $245,711.97 $567,377.30 $671,633.01

26 $30,820.89 $40,709.63 $54,669.13 $121,099.94 $283,568.77 $681,852.76 $813,675.94

27 $32,129.10 $42,930.92 $58,402.58 $134,209.94 $327,104.08 $819,223.31 $985,547.89

28 $33,450.39 $45,218.85 $62,322.71 $148,630.93 $377,169.69 $984,067.97 $1,193,512.95

29 $34,784.89 $47,575.42 $66,438.85 $164,494.02 $434,745.15 $1,181,881.57 $1,445,150.66

30 $36,132.74 $50,002.68 $70,760.79 $181,943.42 $500,956.92 $1,419,257.88 $1,749,632.30

$1,000 invested each year
	Rates
Year	1%	3%	5%	10%	15%	20%	21%
0	$1,000.00	$1,000.00	$1,000.00	$1,000.00	$1,000.00	$1,000.00	$1,000.00
1	$2,010.00	$2,030.00	$2,050.00	$2,100.00	$2,150.00	$2,200.00	$2,210.00
2	$3,030.10	$3,090.90	$3,152.50	$3,310.00	$3,472.50	$3,640.00	$3,674.10
3	$4,060.40	$4,183.63	$4,310.13	$4,641.00	$4,993.38	$5,368.00	$5,445.66
4	$5,101.01	$5,309.14	$5,525.63	$6,105.10	$6,742.38	$7,441.60	$7,589.25
5	$6,152.02	$6,468.41	$6,801.91	$7,715.61	$8,753.74	$9,929.92	$10,182.99
6	$7,213.54	$7,662.46	$8,142.01	$9,487.17	$11,066.80	$12,915.90	$13,321.42
7	$8,285.67	$8,892.34	$9,549.11	$11,435.89	$13,726.82	$16,499.08	$17,118.92
8	$9,368.53	$10,159.11	$11,026.56	$13,579.48	$16,785.84	$20,798.90	$21,713.89
9	$10,462.21	$11,463.88	$12,577.89	$15,937.42	$20,303.72	$25,958.68	$27,273.81
10	$11,566.83	$12,807.80	$14,206.79	$18,531.17	$24,349.28	$32,150.42	$34,001.31
11	$12,682.50	$14,192.03	$15,917.13	$21,384.28	$29,001.67	$39,580.50	$42,141.58
12	$13,809.33	$15,617.79	$17,712.98	$24,522.71	$34,351.92	$48,496.60	$51,991.32
13	$14,947.42	$17,086.32	$19,598.63	$27,974.98	$40,504.71	$59,195.92	$63,909.49
14	$16,096.90	$18,598.91	$21,578.56	$31,772.48	$47,580.41	$72,035.11	$78,330.49
15	$17,257.86	$20,156.88	$23,657.49	$35,949.73	$55,717.47	$87,442.13	$95,779.89
16	$18,430.44	$21,761.59	$25,840.37	$40,544.70	$65,075.09	$105,930.56	$116,893.67
17	$19,614.75	$23,414.44	$28,132.38	$45,599.17	$75,836.36	$128,116.67	$142,441.34
18	$20,810.90	$25,116.87	$30,539.00	$51,159.09	$88,211.81	$154,740.00	$173,354.02
19	$22,019.00	$26,870.37	$33,065.95	$57,275.00	$102,443.58	$186,688.00	$210,758.36
20	$23,239.19	$28,676.49	$35,719.25	$64,002.50	$118,810.12	$225,025.60	$256,017.62
21	$24,471.59	$30,536.78	$38,505.21	$71,402.75	$137,631.64	$271,030.72	$310,781.31
22	$25,716.30	$32,452.88	$41,430.48	$79,543.02	$159,276.38	$326,236.86	$377,045.39
23	$26,973.46	$34,426.47	$44,502.00	$88,497.33	$184,167.84	$392,484.24	$457,224.92
24	$28,243.20	$36,459.26	$47,727.10	$98,347.06	$212,793.02	$471,981.08	$554,242.16
25	$29,525.63	$38,553.04	$51,113.45	$109,181.77	$245,711.97	$567,377.30	$671,633.01
26	$30,820.89	$40,709.63	$54,669.13	$121,099.94	$283,568.77	$681,852.76	$813,675.94
27	$32,129.10	$42,930.92	$58,402.58	$134,209.94	$327,104.08	$819,223.31	$985,547.89
28	$33,450.39	$45,218.85	$62,322.71	$148,630.93	$377,169.69	$984,067.97	$1,193,512.95
29	$34,784.89	$47,575.42	$66,438.85	$164,494.02	$434,745.15	$1,181,881.57	$1,445,150.66
30	$36,132.74	$50,002.68	$70,760.79	$181,943.42	$500,956.92	$1,419,257.88	$1,749,632.30

One thing that you always have to keep in mind is inflation. While the inflation rate is pretty low, about 3%, it's enough to have a big impact on the real return on investments. In general, subtract the inflation rate from the rate of return on an investment and use that for the rate above. Oh dear, a bank savings account doesn't keep up - you might as well spend the money on stuff now instead of waiting until you need it! The better thing to do is find an investment "vehicle" with decent "acceleration".

Return to Finances for Young Adults home page.

Last updated 2007 August 1.