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Saving: The Magic of Compound Interest

Provided by the International Finance Corporation


Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also itself earns interest.  In short, you make money from your money.  Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount.  In fact, Albert Einstein once was purported to have stated,“The most powerful force in the universe is compound interest.”  The below three examples will illustrated the power of compound interest.

Example #1

By instilling the saving habit early in life, even the goal of becoming a millionaire by the age of sixty-five can be reached. By starting at the age of twenty and saving $95 per month, you can end up with a million dollars by the age of sixty-five, assuming a 10 percent return on the money (tax deferred). This is also assuming that none of the money will be withdrawn during the waiting period.

This goal also can be reached if you wait until you are older to start saving, but the amount you must contribute monthly increases dramatically the longer you wait. For example, if you wait until you are thirty years old, you will need to save $263 a month. If you wait until you are forty years old, you will need to save $754 a month, and if you wait until you are fifty years old, you will need to save $2,413 a month.  The below chart also shows how you can reach the $1 million goal by age 65 if you prefer to make a one-time investment, monthly investment or annual investment at various ages.

Age

One-time Investment

Monthly Investment

Annual Investment

20

$13,719

$95

$1,391

25

$22,095

$158

$2,259

30

$35,584

$263

$3,690

35

$57,309

$442

$6,079

40

$92,296

$754

$10,168

45

$148,644

$1,317

$17,460

50

$239,392

$2,413

$31,474

55

$385,543

$4,882

$62,745

60

$620,921

$12,914

$163,797

Example #2

This table illustrates the value over time of $1,000 invested annually (only $84 a month):

Interest Earned

5 Years

10 Years

15 Years

20 Years

5%

$5,526

$12,578

$21,579

$33,066

6%

$5,637

$13,181

$23,276

$36,786

7%

$5,751

$13,816

$25,129

$40,995

8%

$5,867

$14,487

$27,152

$45,762

9%

$5,985

$15,193

$29,361

$51,160

10%

$6,105

$15,937

$31,772

$57,275

11%

$6,228

$16,722

$34,405

$64,203

12%

$6,353

$17,549

$37,280

$72,052

Example #3

Investing $10,000 in a one-time lump sum also pays off:

Interest Earned

5 Years

10 Years

15 Years

20 Years

5%

$12,763

$16,289

$20,789

$26,533

6%

$13,382

$17,908

$23,966

$32,071

7%

$14,026

$19,672

$27,590

$38,697

8%

$14,693

$21,589

$31,722

$46,610

9%

$15,386

$23,674

$36,425

$56,044

10%

$16,105

$25,937

$41,772

$67,275

11%

$16,851

$28,394

$47,772

$80,623

12%

$17,623

$31,058

$54,736

$96,463

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