I’m often writing about the benefits of compound interest.  In fact, Albert Einstein referred to it as “The Eighth Wonder of the World.”  Why?  Let’s see by looking at the difference a few percentage points can make as we compare a 4% compounded rate of return with an 8% compounded rate over a period of 50 years.

Now, simple math tells us that 8% is 2X (or 200% greater than) 4%.  Using this logic without calculating compound interest, we may be tempted to think that an 8% return over 50 years would yield twice as much as a 4% return.  (We might theoretically know compounding makes it grow exponentially, but sometimes we need to see the numbers on paper to really “get it.”)  So, let’s take a look:

Looking at this chart, you can see that after 50 years of compounding, a one-time $100,000 investment at 8% becomes an incredible $5.4 million—732% GREATER than a 4% return of $736,000.  What may seem like a small difference in returns the first few years can add up to a big difference after a longer period of compounding.  It is hard to downplay the difference 4% makes!

Speaking of numbers, here’s a funny story about math (is there such a thing?).

Don’t let one decimal catch you by surprise!  With compound interest, it could cost you thousands of dollars, so take your time and find an option that will make your investments work harder for you.

A few years back when interest rates were very low for interest-bearing accounts, I had to move $600,000 from one bank account to another.  The new banker told us we would collect a little bit of interest on the account.  We knew it wouldn’t be much, but something is better than nothing, right?  The standard interest rate was 0.02%, but with our bigger balance, we qualified for the gigantic rate of 0.06%.  Based on 0.06% interest, the banker said we would receive $60 per year, per $100,000.  Obviously, he made a mistake with the numbers—it should have been $600 in interest—but I thought he just didn’t know how to do math, and I was sad for him since he was the banker.  Instead of embarrassing him by correcting his math in front of other customers, I later sent him an email explaining he had made a mistake: at 0.06% interest, we would be collecting $600 per year, per $100,000.  I felt good about helping him out and saving him from future public embarrassment.  That was the least I could do.

Our guy emailed me back and said he was sticking to his math.  I looked at it again, and lo and behold, he was right! I was the one who couldn’t do the math.  I just couldn’t get my brain to calculate that the interest paid on $600,000 could be that low, so I wasn’t accepting the answer.  I kept multiplying $600,000 x .006 (0.6%) and coming up with $3,600 a year in interest instead of multiplying it by .0006 as the banker had correctly done.  Earning $3,600 a year would have made it worth the hassle of moving the money around.  Too bad I was one ZERO short in my calculation, or one ZERO long, depending on how you look at it.