Compound Growth

Returns on returns

Compounding means your gains start producing gains of their own. Over short periods it is unremarkable. Over decades it becomes the dominant force in the outcome.

Why starting early beats contributing more

Two people, both earning 7% annually:

• Ama invests 200 a month from age 25 to 35, then stops. Total put in: 24,000.
• Ben invests 200 a month from age 35 to 65. Total put in: 72,000.

At 65, Ama — who contributed one third as much and stopped thirty years earlier — ends up with a comparable or larger balance. Her money simply had more time to compound.

This is the single most important idea in personal investing, and it cannot be recovered later by trying harder. Time is the one input you cannot buy back.

The rule of 72

To estimate how long money takes to double, divide 72 by the annual return:

• At 6%, about 12 years
• At 8%, about 9 years
• At 10%, about 7.2 years

The same force, working against you

Compounding is indifferent to direction. Carrying a balance at 22% means the interest is compounding against you at a rate that comfortably outruns what you could reasonably expect to earn investing.

That is why clearing high-interest debt usually beats investing: paying off a 22% debt is a guaranteed 22% return, and guaranteed returns of that size do not otherwise exist.