The Power of Compound Interest (And How It Works)
If I were to ask you what the eighth wonder of the world is, what would you say?
If you asked Albert Einstein, he would say: compound interest.
Yes, a mathematical concept has been nominated as one of the wonders of the world.
Compound interest has also been called the “real route to riches” and “the most powerful force in the universe”.
It’s what allows a regular earner to retire a millionaire, a family to afford the best education for their child and a grandfather to contribute to his daughter’s house deposit.
It’s also one of the main ingredients of the P2P investing pie.
What is compound interest?
Put simply, compound interest is the interest you earn on your interest.
When you make a return on your investment and reinvest it, your principal grows.
As the years go on, the interest you earn keeps increasing because your principal is growing. Over time, this can turn into a small fortune: year 1 you make 10% on 100€, but in year 2 you’ll make 10% of 110€, and in year 3 you’ll make 10% of 121€. This keeps on increasing until you decide to withdraw.
To illustrate exponential growth, we’ll use a classic story between the inventor of chess (named Sessa) and his ruler. The story goes that Sessa challenges his ruler to keep adding grains of wheat to a chess board. The first square has one grain, the second has two, the third has four, and so on.
Each square, the number of wheat grain doubles and the challenge is to reach the last one, square 64.
The ruler laughs and accepts the challenge, only to then realize that the 64th square would require 18,446,744,073,709,551,615 grains of wheat.
In 2020, that’s 2,000 times annual production!
The moral of the story is that although your grains of wheat won’t look like much at the beginning, with a high return, the number of grains you own will increase exponentially and you’ll soon find yourself with more wheat grains than you initially imagined – a nice situation to be in.
Compound interest and money
But, enough about grains – how does this translate to money?
You just need to open up a compound interest calculator and input some numbers to see the magic unfold before your eyes.
We’ll take a real-life example:
Anna invests 100€ every month from the age of 20 and earns a return of 14% every year.
At the age of 60, she will be a millionaire with 1,517,640.70€ in total.
David is wary of investing and prefers saving his 100€ every month and leaving it in a savings account with no interest.
He’s left with just 48,000€ at the age of 60.
That’s a huge difference of 1,469,640.70€.
Compound interest is that extra million and a half.
The craziest part is that even if David decided to invest 200€ per month, but didn’t start until the age of 30, he would have 806,950.99€ by the age of 60.
It’s still pretty good, but it’s over half a million less than what Anna has.
That’s because in the last 10 years of Anna’s investing timeline, compound interest is accelerating her returns at a rate that David would need an extra ten years to get to.
That’s the value of compound interest.
Compound interest and P2P investing
Compound interest is a powerful tool that works for any asset class that offers a return. The only difference is that compound interest is a lot more powerful if your return is higher.
It’s common to refer to the stock market as an example of how compound interest works.
Although it’s correct, the stock market generally offers a return of 8% per year.
This means that if you invest 200€ every month from the age of 20 to the age of 50, you’ll end up with a nice pot of 262,520.97€. But what if your returns were 12%? Or even 16% (like we offer to loyal customers at Swaper)?
The numbers grow quickly.
We’ve put them into a table so you can see just how quickly they grow:
As you can see, with a return of 12%, you’ll have a nest egg of €550,173.79.
That’s more than 2X growth based on an 8% return.
However, with 16%, you end up with 4X growth -and you’re now a millionaire!
Returns make a big difference.
How to maximize your returns with P2P investing
One of the advantages P2P investing has over the stock market is higher returns.
Sure, you can earn higher returns with the stock market, but only if you’re a day trader and are willing to put in the extra effort to learn the ins and outs of business management.
With P2P investing, you can access much higher returns without having to learn what a P/E ratio is or how to read a balance sheet.
With P2P investing, you just need to add your funds, set up your Auto-Invest Portfolio and make sure to reinvest your earnings: Taking advantage of the reinvest functionality is what enables the magic of compound interest.
You can set up a monthly contribution, and then sit back and watch your investments grow.
If you want to reach the highest returns possible, here’s how you can do it with Swaper:
- Register and create an account with Swaper
- Set up monthly contributions
- Create an Auto-Invest Portfolio
- Make sure to turn on “Reinvest”
- Earn a return of 16% with our Loyalty Bonus
- Download the Swaper app so you’re up to date on your investments
With a return of 14% and even 16%, your wealth grows at a much faster rate than if it was in the stock market or in a high-interest savings account. Now you see why compound interest plays such a large role in P2P investing: it’s what turns a small, regular investment, into a fortune.