How Compounding Interests works

This is one of the fundamental principles you should understand and exploit.

The intention is, that each year you leave you principal in the investment and allow the interest to grow. This is in contrast of if you decide to withdraw the interests and only leave the principal.

However, it’s also worthwhile pursuing a different paradigm following these fundamentals

  • Your consider your investment to be “gone”. Hence you will never touch the principal.
  • You increase the principal each year, with the same or a greater amount
  • You leave the interest in the pot, until you are past the first million.

In the following char these principals are depicted with the following conditions.

  • Each year the principal is increased 10.000.
  • All figures are Earnings Before Interest and Tax (EBIT)
  • There are no bad streaks, loses etc. this is a happy scenario
  • The time series span over 30 years.

 Observe the following diagram showing how the principal will scale year over year.

 

For the avid reader it will become evident that investing 10.000$ each year at 7% Interest will make you a dollar millionaire at the end of 30 year.

It also means that each year from there on you will be eligible of receiving 70.000$ in interest EBIT from your investment portfolio.

To further depict the impact of the Return of Investment (ROI) impact, the graph shows from 3 to 10% returns EBIT.

When investing it’s important to remember having a good plan in place to avoid loosing all savings due to default. 

Take a look at various strategies and books here

 

Average growth per year

While 10% growth Year over Year (YoY) is a lot, it is not unlikely. On average the Stock Market yields 6-8% per year, including dividends and price increases.

S&P 500 have had approximately a 10% increase in average since 1928.

For For further details check the spreadsheet picture below. It includes all the necessary figures to understand what happens as interest compounds over time. 

Data Set Compounding Interest

The green markings denotes the year where the return of investment exceeds your yearly contribution. Yellow demarcates 2 x times yearly deposit. blue three times and red 6 times your yearly deposit.

Fetch the spreadsheet from the resources section, in order for you to work with the figures and understand how your Economy could look like 30 years from now.