mathematically insignificant

Albert Einstein: “The most powerful force in the universe is compound interest.”

Interest earning interest can easily supersede even the most optimistic critique’s expectations over time.

The easiest way to explain it, is in the world of finance. After all having a heavier wallet never bothered anybody, except off-coarse if it’s full of IOU slips. Asume $1000 is invested at 10% over time. At the end of year one the investment grows to  ($1000 + (1000 * 10%)) = $1100. If a person reinvests the interest earned the investment will be ($1100 + ($1100 * 10%)) = $1210 at the end of year two.

Investmentvalue @ year n = initial investment*(1+intersest)^n

At the end of 65 years the investment will have grown to $490370.70. Compare that to the $7500 it would have been with nominal interest (when the interest is not reinvested), it is easy to understand what Albert Einstein ment. It makes sense then to try and apply this theorem to other parts of our lives.

For example: Lets take a simple business plan like a video rental store. Assume the store starts of with a 1000 (investment) movie titles. This enables it to attract a certain amount of business. The owner then has two choices. Either he can spend all his profits, which will in effect mean that next month he won’t be able to earn more money (nominal interest), or he can reinvest some or all of his profits and buy some more movie titles (compound interest). Having more movie titles enables him to do more business and at end of next month his profit will have increased, without his profit profit margin needing to increase. If he continues to do this over time his store could even become the biggest company in the world, assuming there is enough demand off-coarse.

Another example: Assume a person wants to become a marathon runner. In the first week he/she runs 10km in one hour on every day of the week (investment). Logic tells us that at the end of the first week his/her fitness will have improved (interest). In the second week he/she will be able to run a little bit further in one hour than the 10km she could manage in the first week. Because he/she is now running further than the first week his/her fitness will also improve more than it did in the first week. If he/she continues to reinvest his/her interest (gained fitness) it is then save to assume that he/she will become a marathon runner in due time (investment objective).

This equation is however not always on our side. A person borrowing money is liable to pay interest over the term of the loan. Over an extended period the cost of the interest could even become several times the value of the initial amount borrowed.

At the end of the day two things are certain. 1. You first need to make an investment if you want to earn interest. 2. If you always reinvest your interest you’ll look back on a profoundly successful life.