Warren Buffett, billionaire and renowned investor, has attributed a large part of his success to one important ingredient – compound interest. It is a simple concept made possible by 2 essential parts: 1) interest earning interest, and 2) the power of time.
In this article, by expanding on the idea of compound interest, we will explore how a small difference in returns could possibly make or break your financial goals.
To begin, it is important to realize that 1% is not just 1% due to the effect of compounding interest. How is that so?
To illustrate, let’s say Anna and Ben both invest a small sum of $10,000 at the same time, with plans to hold it for 50 years in preparation for their retirement. Anna is earning a return of 6%, while Ben is only earning a return of 5%.
While the difference of 1% in their returns might sound insignificant at first glance, at the end of 50 years, this 1% has actually generated $69,528 more for Anna, allowing her to retire more comfortably than Ben.
To break it down further, this is how their portfolio would look like over the years, all things being equal:
As seen, the power of 1% is not to be underestimated as in the compounding world, time is indeed money.
Regardless of your financial goals, be it buying a house, saving up for your child’s college education, or planning for retirement, a small amount will go a long way, with the help of your good friend compound interest.