Compound Interest Explained With One Simple Example
Einstein supposedly called it the 8th wonder of the world. Here is why in one clear example.
You invest $10,000 at 10% annual return. Year 1: you earn $1,000 (10% of $10,000). Balance: $11,000. Year 2: you earn $1,100 (10% of $11,000 — not $10,000). Balance: $12,100. The extra $100 in year 2 is interest earning interest. That is compounding.
Why It Gets Insane Over Time
After 10 years: $25,937. After 20 years: $67,275. After 30 years: $174,494. After 40 years: $452,593. You added $0 after the initial $10,000. Every dollar came from compounding. The growth is not linear — it is exponential. The last decade produces more growth than the first three decades combined.
The Dark Side: Compound Interest on Debt
A $5,000 credit card balance at 24% APR, making minimum payments: 14 years to pay off. Total paid: $11,300 — more than double the original balance. Compounding works against you on debt just as powerfully as it works for you on investments. Pay off high-interest debt before investing (except employer 401k match).