Personal Finance

Getting Rich And Richer With Compound Interest

25 November 2022

If you ask Warren Buffett what is the single most powerful factor behind his investing success, he would say without hesitation, “compound interest”. He has been preaching this concept for more than six decades, and this concept has made him a multibillionaire and one of the investment legends in the world.

On the other end of the spectrum, one of the greatest scientific geniuses, Albert Einstein, had reportedly said that, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it”.

You know that compound interest is an important concept that should not be easily ignored when a world-renowned investment expert and scientist have both advocated it wholeheartedly.

So what is compound interest? To put it simply, compound interest is the interest you earn on interest. This can be illustrated by using a Math example: if you have RM100 and earn 5% interest each year, you will make RM105 at the end of the first year. At the end of the second year, you will have RM110.25. Not only did you earn RM5 on the initial RM100 deposit, but you also made RM0.25 in interest on the RM5 interest earned in the first year. The figure looks small, we may say. But when we dig a little deeper, as shown below, we could see a big difference.

As shown in Table 1, If you invest a sum of money at a return of 10% per year for five years, you will multiply your wealth by more than 1.6 times (rather than 1.5 times using simple or non-compounding interest).

Table 1:

Year Investment return (%)
0 100
1 110
2 121
3 133.1
4 146.41
5 161.05
Total accumulative return (%) 61.10%

As shown in Table 2, If you invest your capital at a rate of 10% for ten times as long as 50 years, you will not only multiply your wealth by 16 times (i.e. 1.6 times multiply by ten). but, by more than 117 times! This means that for the RM10,000 invested in 1970, at a compounded rate of 10% per year, it will be RM1,173,909 in 2020!

Table 2:

Year Investment return (%)
0 10,000.00
1 11,000.00
2 12,100.00
3 13,310.00
4 14,641.00
5 16,105.00
10 25,937.42
20 67,275.00
30 174,494.02
40 452,592.56
50 1,173,908.53
Total accumulative return (%) 11,639%