How compound interest works, or the magic of long-term investing
The best investors in the world invest for the long term, even decades. Among other things, due to compound interest, which works wonders in the long term. Its magic lies in what is known as interest accrual - when the returns from previous investments are reinvested, in a few years the profit will grow exponentially.
(This article is NOT financial advice)
Do you know the proverb “Patience a rose brings? “There is double the cost of investing. The figures show that the best long-term results are achieved by investors who do not sell their investments after a month or a year, but leave them to “work” for many years. They know that with compound interest, time makes them money.
How compound interest works
Compound interest is rightly referred to as The most important principle of investing. This is not rocket science. Imagine him as a snowball driving down a hill and piling more snow on itself. The longer it rolls, the faster it swells. Compound interest works the same way. The basis is to put money into a fixed-interest investment (such as real estate investment loans on Investown), or at least in one that assumes a long-term, albeit variable, return (such as stocks or bonds).
Compound interest is rightly referred to as the most important principle of investing.
And what next? Once the investor earns on the interest on the investment, does not withdraw the money, but reinvests the entire proceeds. Thanks to this, in the next period, he will receive interest not only on the initially invested amount, but also on the money that the investment earned earlier.
Reinvestment refers to the situation when the investor uses the money raised once to make another investment. It can be an investment in the original asset, but also in a completely different asset.
After a year or two, the results are still not so stunning, but already in 5-10 years the effect is huge. When an investor uses the power of compound interest over such a long term, profits grow exponentially and as a result reach up to Tens of a percent higher yield.
Example: How much compound interest will he earn in 10, 20, and 30 years?
The principle of compound interest is great even on a theoretical level, but nothing compares to concrete examples. Therefore, we have prepared one model situation below. Petr Novák posted 70 000 CZK to invest with fixed income 10% per annum. After the first year, he will have 77 000 CZK (total income for the year is 7 000 CZK). In the coming years, Mr. Novak will gradually begin to benefit from compound interest. Since he did not withdraw the profit of CZK 7,000, but reinvested it further, in the second year the interest of 10% will not be valued at the original CZK 70,000, but already CZK 77,000. If he keeps going and doesn't sell the investment, the returns will grow exponentially. After 5 years, Petr Novak will have a total of 112,000 CZK. But he is thinking long term and wants to have enough reserve for retirement, so he perseveres. In 10 years, he will see in his investment account more than double the amount of the original deposit: 181,562 CZK. In 20 years it will be 470 925 CZK and in 30 years he will have a beautiful 1,221,458 CZK.
The example nicely shows how huge exponential growth is when an investor invests for decades. Since the compound interest principle works perfectly and time plays in Mr. Novak's favor, Most people earn between 20 and 30 years of investment.
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Investing is not worth waiting
Mr Novak's example also shows how important it is not to procrastinate and start investing as soon as possible. Even a few years will make a huge difference in the overall yield.
If Petr Novak had invested his 70,000 CZK up to 10 years later, He would only have invested for 20 years, had to retire. saved 750 533 CZK less (o 61.4% less of the total amount).
It is also good to know that the resulting return could be many times higher if, in addition to betting on the initial one-time investment, Mr. Novak had invested regularly, for example CZK 5,000 per month.
Mr Novak's example also shows how important it is not to procrastinate and start investing as soon as possible.
Compound interest also works well at Investown
Compound interest yields the best results for fixed yield/interest investments. It is in such investments that all investors on Investown value their money. Profits from investments in addition they get paid monthly so they can reinvest the money sooner than in a year.
This article is not investment advice
Investown does not provide investment advice. This is an educational article with basic information about compound interest. For specific advice, we recommend using the services of an investment advisor.
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