Compounding

This is information about the magic and power of Compounding Interest.

Albert Einstein's Theory of Relativity is generally credited with developing the concept of time being the fourth dimension of the universe. This concept is also found in the investment world. Einstein said that compound interest is "the greatest mathematical discovery of all time." Time is the best friend of a prudent investor.

Here is a dramatic example of the power of compounding: Peter Minuit bought Manhattan for $24. If he, instead, invested his $24 at 6.5 percent interest it would be worth more than the value of all of today's property in Manhattan!!

Here are some other examples:

The following graphs dramatically illustrate this concept. The first one shows how a single, one-time investment of $10,000 will grow at 12% (the rate of return of stock market during the past 40 years). The $10,000 grows to $931,000 in 40 years! It dramatically shows the power of Time.

The second graph below adds the element of Rate of Return. It compares the 12% return of the stock market versus 5% (a rate approximately what an insurance company TSA usually pays). At 5% the same $10,000 grows to $70,400 over 40 years, a difference of over $860,000! This means that if teachers choose an insurance company TSA rather than investing it themselves directly, they also choose to lose $860,000. If they would invest it themselves, they would make 13 times more profit. This could explain why the insurance companies and their agents are so anxious to sell teachers their plans.

The magic of compounding is graphically illustrated by the ever increasing slope in the later years compared to the little difference in the early years. It is so dramatic that just one year more year past 40 would produce over $100,000 more, without adding any more money! And every year thereafter the increases are even greater. This explains how the rich get richer, but, even more important to understand, it shows that this is available to anybody who starts early and wants to retire with enough money to live comfortably. It's never to late to begin. Teachers can do it so easily if they just begin and stick to a good plan.

A good plan for a teacher would be to invest a regular, set amount every month. If they would do that the results become even more dramatic. The charts above assume a one time investment of $10,000. Now consider the results if money is invested on a regular, monthly schedule. Below is a table that shows how much money a teacher could have, year by year, if the 403(b) money is put into an investment that pays them 12%. It also assumes an annual investment of $10,000.

	Annual	Total	Year end	Total
Years	Investment	Invested	Profit	Value
1	$10,000	$10,000	$1,200	$11,200
2	$10,000	$20,000	$1,344	$22,544
3	$10,000	$30,000	$2,705	$35,249
4	$10,000	$40,000	$4,230	$49,479
5	$10,000	$50,000	$5,938	$65,417
6	$10,000	$60,000	$7,850	$83,267
7	$10,000	$70,000	$9,992	$103,259
8	$10,000	$80,000	$12,391	$125,650
9	$10,000	$90,000	$15,078	$150,728
10	$10,000	$100,000	$18,087	$178,815
11	$10,000	$110,000	$21,458	$210,273
12	$10,000	$120,000	$25,233	$245,506
13	$10,000	$130,000	$29,461	$284,966
14	$10,000	$140,000	$34,196	$329,162
15	$10,000	$150,000	$39,499	$378,662
16	$10,000	$160,000	$45,439	$434,101
17	$10,000	$170,000	$52,092	$496,193
18	$10,000	$180,000	$59,543	$565,736
19	$10,000	$190,000	$67,888	$643,625
20	$10,000	$200,000	$77,235	$730,860
21	$10,000	$210,000	$87,703	$828,563
22	$10,000	$220,000	$99,428	$937,990
23	$10,000	$230,000	$112,559	$1,060,549
24	$10,000	$240,000	$127,266	$1,197,815
25	$10,000	$250,000	$143,738	$1,351,553
26	$10,000	$260,000	$162,186	$1,523,739
27	$10,000	$270,000	$182,849	$1,716,588
28	$10,000	$280,000	$205,991	$1,932,579
29	$10,000	$290,000	$231,909	$2,174,488
30	$10,000	$300,000	$260,939	$2,445,427
31	$10,000	$310,000	$293,451	$2,748,878
32	$10,000	$320,000	$329,865	$3,088,743
33	$10,000	$330,000	$370,649	$3,469,393
34	$10,000	$340,000	$416,327	$3,895,720
35	$10,000	$350,000	$467,486	$4,373,206
36	$10,000	$360,000	$524,785	$4,907,991
37	$10,000	$370,000	$588,959	$5,506,950
38	$10,000	$380,000	$660,834	$6,177,784
39	$10,000	$390,000	$741,334	$6,929,118
40	$10,000	$400,000	$831,494	$7,770,612

As this chart shows, a total investment of $400,000 grows to almost $8,000,000. It is also evident from this chart that the later years is when the greatest growth and profit occur. Even more astounding, one more year of compounding, the 41st, will add One Million Dollars to a teacher's net worth. By continuing the compounding an additional 4 years would add about Six Million Dollars. Is it any wonder that Einstein was so impressed with this phenomenon?

Click here to see a true to life story of the importance of starting early.

Go on to learn about investments for teachers