Compound interest helps young investors tremendously. You’ve probably read that somewhere before. But why is this, what makes compound interest so powerful? And why should you care if you’re young?
What is Compound Interest?
My friend over at The Poor Swiss recently wrote about whether compound interest is magic. Although I encourage you to read their article, the short answer is no. Compound interest is not magic.
However it is a truly magical concept. Think about it. Your money grows a little bit this year, some more next year, and a metric shit ton 40 years from now.
The reason is that when you get a periodic interest, the next period you receive interest over your principal amount + the interest from the previous period.
The easiest example is that with a principal balance of 1,000 EUR and a 10% yearly interest. The first year you receive 100 EUR in interest, and have 1,100 EUR. But the second year you receive 110 EUR and have 1,210 etc. After 10 years the yearly interest alone would be 236 EUR, after 40 years it will be an amazing 4,114 EUR or more than 4 times your original principal!
How Young Investors Win
Young investors have this incredible power called time. As you have seen in the example above, compounding interest pays the most when you can do it for a very long time.
If you have only 3 years to save, interest will not help you that much. If you have 10 years, it will make a difference. If you have 40 years, you can be extremely wealthy!
Young people usually don’t want to think about finances. That’s what I hear around me, but also experience first-hand. My colleagues that are just starting in their early twenties never go to introduction meetings about the retirement plans because it’s so far out it doesn’t matter.
Maybe they should care. It will make them
fucking extremely rich!
Yes, You Can Be Rich!
If you start early enough you can definitely be rich. As said before, compound interest helps young investors!
My earlier example is flawed in two ways. First, the interest rate of 10%, although nice for math, isn’t really realistic. I’d rather calculate with 7%. In the graph below you can see how your initial 1,000 EUR would grow over the course of 40 years. I choose 40 years because this is the average investment timeline of someone in their twenties that start to work.
The second way the example was flawed is that nobody actually uses a one-time investment and then sit still for decades. Your investment will probably start from zero, and then you will periodically add money to your accounts.
In the chart below you can see how a 250 EUR per month (3k per year) investment will grow over 40 years, given the same 7% return as in the example above.
This will lead to a wealth of over 600,000 euros with an invested principal of just 120,000. Now, who’s crazy for being financially active in his twenties? Oh and by the way, even if you start out saving 250 per month, you will probably be able to start saving more and more, increasing your future wealth even more.
Please please please. If you’re young and want to do something your future self can be proud of, start investing today!
Also, if you’re old, start investing today! The best time to plant a tree is 20 years ago. The second-best time is today.
How to Begin Investing for Compound Interest
First, you should define your investment strategy. I have written extensively about mine. Yours can be different. Whether you will invest in stocks, bonds, crowdlending, or real estate doesn’t matter. All that matters is that you start investing and to do that you have to create a strategy for yourself.
Secondly, make sure you actually can invest by opening an account at a broker. I recommend online broker DeGiro, but others might work well.