# The Power of Compound Interest

According to Albert Einstein, “compound interest is the greatest mathematical discovery of all time.” In simple terms, compound interest earns interest income on your interest income, thus growing your money faster than ever. Most savvy investors use the power of compound interest to capitalize on the benefits of compounding and get rich even during the hardest of times.

Understanding compound interest

To better understand how compound interest works, let’s assume that you invest \$200 at an 8 percent earnings rate. At the end of year one you will have \$216, which is \$16 earned in interest. If you invest the \$216 for another year at 8 percent, at the end of year two you will have \$233.3, which is \$17.3 earned in interest. Put the \$233.3 for another year at 8 percent and at the end of year three you will have \$251.97, which is \$18.7 earned in interest. In three years you have earned almost \$52 on your investment, which, given the current market situation and the global financial crisis, is a crazy number.

There are three factors that influence the rate of compound interest: (1) the interest rate earned on your investment, (2) the investment horizon you can leave your money to compound and (3) the tax rate and the timing that the taxes should be repaid to the government. In fact, the longer the investment horizon, the bigger the return on your investment. In the above example, the interest earned in three years is \$52. If the money is reinvested for another seven years the total return on investment in ten years will be almost \$200. Regarding taxes, you will have more accumulated capital at the end of ten years if you don’t pay taxes at all or if you pay once and for all at the end of the compounding term rather than each year.

The importance of starting early