Compound Interest Changed My Financial Trajectory

compound interest einstein

Compound interest is known as the “8th wonder of the world”.  This quote has been attributed to Albert Einstein, but never confirmed.

If you understand how it is calculated, it’s an amazing mathematical truth that can work for you, or against you.

It can work against you if you carry debt and barely pay the minimum payment.  Interest is compounded and you end up digging a hole so deep, it is difficult to climb out.

On the other hand, it can work for you, if you are able to have assets that appreciate or pay divdidends over time.

The Moment I Learned Compound Interest

Growing up, my parents would watch a bit of TV before winding down for the night and after a long day of work and chores.  Typically, they’d watch Jeopardy followed by Wheel of Fortune.  Sometimes, they tune into PBS to see a documentary.

One day, I walk into my parents room, and they were watching someone named Suze Orman on PBS speaking to a crowded theater about retirement.  This was the late 90’s.  Suze wasn’t popular then, but she had just published her first book.  Since then, she’s published a ton of other books.

Around the same time, the Roth IRA was established by the Taxpayer Relief Act of 1997 and named for its chief legislative sponsor, Senator William Roth of Delaware.

I remember sitting there while my mom said something along the lines of “you should think about putting money into this Roth account.”  I remember Suze walking the audience through how much someone would have at retirement if they invest a fixed amount every year.  The final number blew my mind!  I don’t remember the exact example that she used, but someone who contributes $5,000 every year at 7% returns for 40 years would have over $1,000,000.

I didn’t quite understand how that was mathematically possible…until I did the calculation myself.

The Revelation

I am pretty good at Microsoft Excel so I ran some quick numbers and was shocked with how much accumulated over time.  In my example, I assumed a 7% growth rate and an annual contribution of $5,000.

Compound interest table

When I converted the table to a line graph, it was even more astonishing.

Compound interest graph

The more time you have, the faster things compound!

My goal from that moment on was to get as far right to the curve as possible.  I was still in college at the time, but contributed as much as I could to my Roth with money earned from summer jobs.  I continued this trend early in my career and even now in my early 40’s.

My Personal Results Of Compound Interest

Below is my actual net worth chart from 2002 until now (I removed the actual net worth, but I send out my net worth reports if you subscribe!).  I knew my net worth in 2002 because I just graduated college with student loans.  In 2002, I had no other assets, so my net worth was negative.  There’s a big gap between 2002 and 2007 since I didn’t track my net worth during that time.

compound interest actual

Notice that my actual compound interest curve looks similar to the hypothetical one I developed in Excel. Despite going through a few recessions including the 2008 great recession, compound interest has been able to accumulate nicely.

If there’s one thing you need to take away, its that you should start saving now…and as much as you can.  As you can see from this real life example, compound interest works.

4 comments

  • I love playing with the compound interest calculator on Investor.gov … Take your same example and make it $5,500/year (roth ira limit) rather than $5000 and add 4 more years (35 years instead of 31) and you end up with $818K (almost double with 2 small changes)

  • I wish I had the numbers to track since I finished pharmacy school. I’ve been using Mint a long time, I wonder if I can dig up (close) to that in there.

    I sometimes wonder how my net worth is as high as it is considering how long I’ve been out of school and that we’ve already paid off a house (along with other larger purchase over time, especially when it first graduated pharmacy school).

    The only thing that makes sense is compound interest. I save well, but, still not enough to demonstrate my gains when I do the math.

    Doing some quick math and accounting for only some very big purchases that stand out (vehicles, House, weddIng, etc), and knowing that we’ve probably been becoming more efficient over time since I finished school (I had to pay rent on two places for work reasons my first two years out of school)… if you only account for networth and no compound interest that would mean we’ve lived off 20k or so a year since I finished school.

    My whittled down budget puts us at about 40k per year, so.. all those gains since getting a real job attributable to compound interest.

    It really makes a difference.

    Now if only I had started with an IRA instead of CDs in high school!

    • financeforthefamily

      Sounds like you’re doing well regardless! I missed a few years of tracking, but have consistently tracked for the past 10 years. I would imagine compounding has played a big role in your net worth, in addition to reduced spending, and investing the difference.

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