Einstein referred to the law of compound interest as the eighth wonder of the world. It truly is a remarkable thing. You’d think, as someone who works in the investment world, it would become an ordinary subject for me, but I get fired up every time I think about it. I’m amazed each time I show a picture of it in action.
Clients often disbelieve what it can mean for their retirement account values when projecting it. How is that end number even possible? The awe-inspiring part of compounding actually happens in the final third of the process, when you are doubling a very large amount compared to early in the process. Hence, why you hear all too often why you should start investing when you are young. If you can get your account to $1 million before the final double period, you obviously get $2 million. Think what your account value is currently. Now, try doubling that four or five times. I hope that’s an inspiring number.
Historically, the stock market has provided a doubling of your account every eight to 10 years. Most people should be able to turn every $1 saved at age 30 into $32, should historic returns continue. Taken another way, every $1,000 should turn into $32,000! If you can save $30,000 by the age of 30, you should have over $850,000 by the time you turn 80. That’s without ever saving another penny.
Compounding works its magic from a mathematical standpoint by receiving interest upon interest over and over. That’s the wonder Einstein spoke about, but the driving energy behind how you receive historically high interest is also a fascinating topic to me.
Living in a world of abundance makes it possible to create more and more value to be shared. We aren’t simply shuffling resources around by hoarding them completely from others. As an entrepreneur improves on a process, solves a problem, and services people better, they create value both for the customer and for those who own the enterprise.
When you invest your money in the overall stock market, you are taking ownership in multiple companies who pass the creation of value on to you in the form of appreciated stock and interest dividends. Jesus, in the parable of the talents, tells us that it’s wrong to hoard our money and bury it in the ground. That doesn’t help create value in our abundant world.
The rule of 72 tells you roughly calculate how long an investment dollar will take to double by dividing 72 by the annual rate of return. For example, if you receive 9 percent return, your money should double roughly every eight years. The higher your return, the more times your money will double over a given period of time.
Fortunately, we live in a country with laws and a court system that allow entrepreneurs to tackle our biggest needs, desires and problems. Compared to much of the world, we also get to keep a good portion of the value created in our wallets. Our country will certainly continue to have periods of great uncertainty, but I believe the entrepreneurial spirit that creates great wealth is alive and well. This will hopefully continue to provide us the wonderful opportunity to enjoy a very high annual rate of return and compounding going forward.
Aaron Pickert, CRPC, is associate adviser at Stewardship Capital in Independence. Past performance is no guarantee of future results. Advice is intended to be general in nature.