Archive for December, 2012

The Magic of Compound Interest with a Growing Principal


I’m a strong believer in the power of compound interest.  Do you remember back in your 7th grade math class when you learned the equation P = e^RT?  I don’t know why, but that lesson stands out very clearly for me, and I even remember where I was sitting in my classroom at the time.  I was also considering a lucrative summer job involving corn detasseling that year.  It would have been hard work, and looking back, I’m not sure why I didn’t do it.  I think that was the first time I seriously started thinking about (making) money.  I just wish I had known more about the power of investing, instead of saving.

So, let me put this out there, and you can check this math later when I post the formula…  If you search on Google for ‘compound interest’, you’ll get hundreds of results describing scenarios where the principal investment value is fixed.  I don’t agree with this.  You should always continue putting money into your investment account, and the formula to describe this is actually tough to find on the web for some reason.

Here we go…..

Let’s assume you start an investment account (stocks!) with $0 for the principal.  (Horrible situation for growth, I know, but it’s a realistic scenario.)
Let’s also assume you decided you can afford (or… even better.. you have forced yourself to afford) to invest $100/month into this account.  Think of this as paying an extra $100 bill every month (ouch), but that bill is being payed directly to YOU, and not to an evil cellular, TV, or Internet service provider company.
Now let’s assume you continue paying this “bill” for 30 years, and that you’re getting 3% APY (annual percent yield) through dividends.  –This is way better than a savings account, by the way.
After 30 years, your $100/month investments add up to $36,000, but because of the compound interest, you get an EXTRA $22,000 on top of this.  If you add in the gains from these stocks, you’ve suddenly (pretty easily) doubled your money.

I don’t think 3% is too difficult to achieve though, and $36,000 + $22,000 is not that much money in the grand scheme of things.  I mean, that might help you pay for 1 semester of your child’s future college education the way things are going!!

Now, here’s the exciting part.

If you do the EXACT same thing as above ($100 every month for 30 years), but you can increase the APY to 8%,  your EXTRA $22,000 suddenly becomes $212,000!

Say whaaat?!

I tried to tell you, this blog is ‘Not Fo’ Yo’ Mamma!’ investing.

If you can start out with a $5,000 or $10,000 principal (instead of $0), and your stocks also go up in value, which is likely after 30 years, you’re suddenly an instant millionaire!  Ta daaa.