Compound Interest: The Eighth Wonder of the World

The Seven Wonders of the World are familiar to most, but have you ever heard of the eighth wonder? According to Albert Einstein, compound interest holds this prestigious title. In his famous words: “He who understands it, earns it; he who doesn’t, pays it.” But what exactly is compound interest, and why is it so powerful?

What is compound interest?

Compound interest is, in simple terms, interest earned on both the principal amount and the accumulated interest from previous periods. In other words, it’s a mechanism where your interest earns interest. For example, if you invest 100 francs at an interest rate of 10%, you’ll have 110 francs at the end of the first year (100 + 10). If you reinvest that 10 francs of interest, the next year, you’ll earn 11 francs in interest (10% of 110). By the end of the second year, you’ll have 121 francs. This process may seem modest initially, but over time, its effect becomes exponential.

Example calculation:

• Initial Investment: 100 francs
• Interest Rate: 10% per year
• After 5 years: 161 francs
• After 10 years: 260 francs

In this scenario, your capital has more than doubled in just ten years. And this growth accelerates the longer you leave your money invested.

The exponential effect: the longer, the more powerful

The magic of compound interest lies in its ability to grow your capital exponentially, rather than linearly. This phenomenon applies not only to bank interest but also to all investments that generate returns, such as stocks, bonds, and investment funds.

Let’s consider an example with the Swiss stock market. If you had invested 5,000 francs in Swiss stocks ten years ago, with an average annual return of 7%, your capital would now be around 9,836 francs. Why? Because you would have reinvested the gains each year, allowing your investment to snowball over time.

The rule of 72: A magic trick to double your money 🎉

A simple way to calculate how long it will take to double your money is the Rule of 72. Just divide 72 by the interest rate or return on your investment, and you’ll know how many years you’ll need to wait for your money to double.

For example, if you expect a 6% annual return:

• 72 ÷ 6 = 12 years to double your money.

Comparison:

• Savings account at 0.4%: 72 ÷ 0.4 = 180 years to double your money.
• Investment at 4%: 72 ÷ 4 = 18 years.

As you can see, with today’s low interest rates on savings accounts, it’s far more beneficial to invest in financial products like ETFs or stocks, which automatically reinvest profits to maximize the power of compound interest.

How to benefit from compound interest

To take full advantage of this eighth wonder of the world, it’s crucial to reinvest the interest or dividends generated by your investments. Financial products like capitalization ETFs, which automatically reinvest profits, make this process seamless. It’s an excellent way to maximize your long-term returns.

The Importance of Starting Early

The key factor in leveraging compound interest is time. The earlier you start investing, the more powerful compound interest becomes. For instance, if you invest 200 CHF per month at an interest rate of 4% at the age of 25, you will have nearly 140,000 CHF by the age of 65. If you start only at age 35, you’ll accumulate about 100,000 CHF less, despite contributing similar amounts.

Compound interest, a long-term financial powerhouse

Compound interest is undoubtedly a powerful tool for long-term financial growth. It works quietly in the background, multiplying your capital far beyond what you could expect from a simple savings account. The longer you let time work, the more powerful compound interest becomes. So, start now by investing in products that automatically reinvest returns and unleash the full potential of this “eighth wonder of the world.”

“Compound interest is like planting a tree that grows slowly at first, but eventually turns into a forest. Even better, this forest gives you fruits… which then turn into more forests! Not bad for a financial gardener, right?”

Compound Interest Formula

The formula for compound interest is simple but powerful:

Where:

• VfV_fVf​ is the final value (what you’ll have in the future),
• ViV_iVi​ is the initial investment (starting capital),
• $p$ is the interest rate (in percentage),
• $n$ is the number of periods (usually in years).

Example Calculation:

Let’s say you invest 6,800 CHF at an interest rate of 2% for 35 years. Using the compound interest formula:

With this formula, you can calculate how your investments will grow over time, helping you plan for your financial future.