Last Updated: November 30, 2018, 11:06 pm

The College Investor: What is compound interest?


Creative Commons.

“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it,” said Albert Einstein, one of the smartest men in human history. Despite his words, few people know what compound interest is and even fewer understand its power.

So what is compound interest?

Quantitatively, compound interest is represented by exponential growth. In other words, each increase builds upon previous increases, creating a snowball effect.

Peter Kaufman, respected investor and author, has qualitatively defined compounding as, “Dogged, incremental, constant progress over a very long time frame.” This is where the saying “get one percent better every day” comes from. In fact, improving by one percent each day would leave you nearly 38 times better after only one year.

But how does compound interest affect your life, and in what areas?

Compounding influences many aspects of life, including wealth, wisdom, fitness, longevity, and happiness.

In wealth, for example, $1,000 invested at seven percent compounded annually will turn into more than $57,000 after 60 years. The same amount earning 15 percent annually will turn into more than $4.3 million.

To illustrate the long-term power of compounding, we will look at an example in US real estate. In 1626, the Dutch purchased the island of Manhattan from the Native Americans for $24. If the Native Americans had invested their $24 at a compounded rate of seven percent annually, they would have over $7.9 trillion today. This is the power of compound interest.

It’s difficult to measure the impact of compounding in areas of life such as wisdom, fitness, longevity, and happiness, but the majority of those who achieve success in these areas harness the power of compound interest.

Wisdom comes from learning, through your own experiences and those of others, and the wisest people often read and think deliberately and often.

Fitness and longevity reward those who are constant with their workouts and nutrition.

The happiest individuals invest high-quality time in their relationships and compound the joy that comes from them.

A compounding approach to self-improvement has led to incredible results for many people. Compounded outcomes are unimpressive in the beginning and jaw-dropping in the end.

Bill Gates sums it up nicely by saying, “Most people overestimate what they can do in a day and underestimate what they can do in a lifetime.”

You will be rewarded for taking the time to learn about compound growth and applying a constant, disciplined approach to self-improvement.