Compound Interest/Compound Returns

Even in today’s environment when investment returns are historically low, investing early has a huge impact on future value of investments. Take the example of $1,000 invested at age 20 versus $1,000 invested at age 40.  With an return of 7%, that $1,000 invested would be worth $5,427 for the 20 year old at age 65 and $21,002 for the 40 year old at age 65.  That’s almost 4X more! That’s the effect of compound interest. The first year the $1,000 invested makes $70 (at 7%).  The second year , the return is calculated based on the original $1,000, plus the $70 that was earned the first year. So instead of the $70 return in the second year, the return is $1,070 X 7% = $75. In the 3rd year, the return is $80. So, by year 20, when the 40 year old is just putting their $1,000 to work, the 20 year old is making $271 that year, compared to $70 for the newly investing 40 year old. The compounding is shown below:

20 Year Old:

Year 0: $1,000

Year 1: $1,070

Year 2: $1,145

Year 3: $1,125

....

Year 43: $18,344

Year 44: $19,628

Year 45: $21,002

40 Year Old:

Year 20: $1,000 (Year 0 for the 40 Year Old)

Year 21: $1,070

Year 22: $1,145

Year 23: $1,125

....

Year 43: $4,741

Year 44: $5,072

Year 45: $5,427

You can also play with this yourself using the link below:

https://www.investopedia.com/calculator/fvcal.aspx

The point of this example is to demonstrate the power of compounding and the huge advantage an investor has if they can invest early, reinvest the returns and have those returns generate even more returns – a snowball effect. That is the reasons all Financial Advisors encourage you to invest as early as you can in your life and let compound interest work for you.

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©2020 BY SMART INVESTING FOR CANADIANS

All articles herein are presented as an educational resource and should not be considered as professional financial or individualized investment advice. Readers should always exercise their own judgement when making any decisions about their money.

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