Compound Interest

Albert Einstein described compound interest as one of the most powerful forces in the universe and for good reason. If you have read debt horror stories then you will know all too well how quickly compound interest can mount up on you, but on a positive note you can use compound interest to your advantage too.

If you deliver good returns on the stock market for a year, great, you have done well. But if you can consistently beat the market for say 25 years, then your investment returns will be truly awesome. One great testament to this is Warren Buffets Berkshire Hathaway investment vehicle- it has rewarded its early investors massively, as the share price is currently around the $100,000 mark.

This graph shows the effect of experiencing different annual rates of return on an initial investment of £1000, compounded over 25 years. Notice the difference between 20% and 21% over 25 years - every single percentage point counts.

Compund Interest Formula

Total Return=Initial Sum x ((1+(Rate of return/100)) to the power of (number of years)

This looks quite complicated, but it isn't- its just had to draw it on a computer! Here is an example- say we know we are going to get a 6% return compounded for 10 years, and have £8000 to invest.

Total return= 8000 x (1+0.06) to the power of 10
=8000 x (1.06) to the power of 10
=8000 x 1.79085 = £14326.78