Compounding...

If I was a high schooler…

The law of compounding

I am close to 50 now and am an executive of a US public company. I was born and raised in a third world country, and, by God’s grace, I had the opportunity to migrate to the US twenty years ago and start my life in this country. Certainly now, I can look back and wish to live my life differently, especially in the financial world. So, I simply wish to share my thoughts for the younger generation for them to benefit.

I have learned about the law of compounding since high school. However, I failed to appreciate the significance of this law. While I started saving early, even during my primary school time, I was only exposed to investing in the bank and relied on bank interests for my investment returns, which were very minimal (I recollected to only like 1 or 2% annually). Certainly, looking back, as a third-world country, it did not give as many investment opportunities as I see in the USA. Hence, I wondered that, given the knowledge that I have and the investment opportunities that exist in the US, what would I do differently?

Just as a background, the law of compounding (or compound interest) means earning interest not only on your original principal but also on the interest that your investment generates. Compound interest is sometimes described as “interest on interest” because earned interest essentially gets added to the principal over time. With this, one would appreciate that the earlier you started, the more headway you have in terms of your investment. Let’s take a specific example here:

A 15-year-old invests $5,000 every year for 10 consecutive years. After age 24, no additional investments are made, and the money is left to grow until the investor reaches age 55.
A 25-year-old invests $5,000 every year for 30 consecutive years until retiring at age 55.

Let’s assume an 8% interest rate annually with a retirement age of 55.

The individual who started investing at 15 years old and made 10 total payments of $5,000 will end up with approximately $787,180 at age 55.
The 25-year-old who made 30 total payments of $5,000 will end up with approximately $611,730 at age 55.

Now, we can see that a high schooler (15 years old) who only invested with $5,000 for 10 consecutive years beats a college graduate (25 years old) who invested with a similar $5,000 but with a much longer period of 30 consecutive years.

So, the moral of the story? Invest early.

"Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it," - often attributed to Albert Einstein