Compound Interest is the Eighth Wonder of the World

The above quote is often attributed to Albert Einstein, there’s a little more to the quote: “Compound interest is the eighth wonder of the world, he who understands it, earns it, he who doesn’t…pays it”. 

Compound interest is magical!  It’s amazing!  It’s not often you see boring Sunshine Coast financial advisers like me getting so excited – but if there’s one way to get me excited it’s to discuss the magic of compound interest! 

Here’s a good way to visualize it.

You head on over to Chess on Buderim (https://suncoastchess.com.au/).  You ask to borrow one of their chess boards:

You take the chessboard and you go and see the King (or Queen!) of the Sunshine Coast.  Okay, there’s no King, but if there were a King on the Sunshine Coast, you’d probably find him here: https://sunshinecastle.com/history-sunshine-castle/.  There is indeed a Sunshine Coast Castle.  It’s just round the corner from where I live in Twin Waters, it’s in Bli Bli!

Anyway, the King is a chess enthusiast.  He’s a very good player and rarely loses.  One day a travelling sage is passing through Bli Bli.  This was in the days before wise financial planners, like Mike, were roaming the Sunshine Coast, thus our pre-sunshine-coast-financial-planner-sage challenges the King to a game of chess.  The King says to the sage “name a prize that you would like if you win”.  The sage asks for one grain of rice on the first square of the chessboard. The king got perplexed and asked, “That’s it?” The sage continued and said, two grains on the next square, then four grains on the next, and so on, such that each square has double the amount of the previous one. The king was baffled, the sage could have asked for any valuable reward he wanted. Nonetheless, he immediately agreed, as to him it looked like a very small prize. The sage was a brilliant player and defeated the king. Having lost the match and being a man of his word, the king called his treasurer to reward the winner. His officials started putting the rice onto the chessboard. They put one grain on the first square, two grains on the second, four grains on the third, then eight, 16, 32, 64, and so on…The quantity started to look much more than what the king expected it to be at the start. It was increasing exponentially with every next square. By the end of the fourth row, the king needed 2.1 billion grains of rice! He now started becoming anxious and asked his officials to estimate the total rice needed to reward the sage. The answer made him realise that the number of grains required was far beyond the capacity of the chessboard, his palace, and indeed his entire granary!  Wondering how much it was? Well, the figure came to a whopping 18,446,744,073,709,600,000 (18 quintillion 446 quadrillion 744 trillion 73 billion 709 million and six hundred thousand) grains of rice!  The same applies to your investments as well because the returns compound over a period of time. For many people, just like the king, this concept of compounding doesn’t occur.

To look at this another way:

Let’s take a look at some real life examples. 

Example One – Dithering Donna, age 50, didn’t come and see Sunshine Coast Financial Planners, starts saving $15k p.a. at age 50, 7% p.a. return, retires at age 65.

What does Dithering Donna end up with?  $377k.  She’s contributed $225k ($15k x 15 years) and she’s earned a little interest along the way, $152k.  But let’s see the benefits of a little more compounding…

Example Two – Wise Willy, age 35, does a Google search for ‘Sunshine Coast Financial Planners’, pops in to see Mike Beal and the Team, sees the benefits of compound interest and rather than waiting to age 50, Wise Willy decides to immediately start saving $15k p.a. Willy also receives 7% p.a. – but Willy has an additional 15 years of savings.

Well, an extra 15 years of saving for Willy: 15 years x $15k = $225k.  So Willy should have an additional $225k (15 x $15k) of savings (plus the 7% p.a. interest along the way).  But if Donna’s got $377k – and Willy’s saved an additional $225k that he’s saved then Willy will end up with $377k + $225k = $602k, something like that…plus the compounded interest along the way, right?  How much does Wise Willy actually end up with?  $1,416,912!  He’s only contributed an additional $225k – but he ends up with an additional $1,040,000!  This is all due to the long-term magical effects of compound interest!

Why not plug in your own examples?  We have a compound interest calculator on our website: https://www.mikebealfp.com.au/compound-interest-calculator/

Ronald Read vs Richard Fuscone

Who’s Ronald Read?  Ronald Read, according to CNBC, was a Vermont gas station attendant and janitor, who invested in recognizable share market names and amassed an $8 million fortune by the time he died, according to his attorney. A large part of that fortune was later bequeathed to an area library and hospital after his death, stunning a community that had no idea about his wealth.  Now to Richard Fuscone….He is the former Chairman, COO and Global Head of the Fixed Income Group of Merrill Lynch Investments. He built and managed the largest global fixed income franchise on Wall Street from 1979 to 2000.  He studied history at Dartmouth and achieved an MBA at the University of Chicago. He became the founder and CEO of an investment advisory firm.  Clearly this wasn’t the best financial advisory firm – the best financial planning firm on the Sunshine Coast is obviously Mike Beal Financial Planning – which is why you’re reading this fascinating compound interest story on our website!  Anyway, back to Richard Fuscone, he was so successful in his career that he retired in his 40s to pursue philanthropic work.  He also built a massive property and built up a lot of debt.  And went bankrupt in 2010. 

But really, this is another great story of compound interest because our janitor was 92 when he died, so he had the benefit of many, many years of compounding – even small amounts compounded over a very long period of time can become colossal fortunes.  Like the Wise Willy example, it’s this long-term compounding that has the greatest effect.  If Wise Willy did the exact same thing, i.e. $15k/yr savings, 7% p.a., but instead of 30 years he did it for sixty years, instead of the $1.417m he would have ended up with after 30 years – over 60 years he would have $12.2 MILLION! 

Warren Buffett vs Jamie Simons

You’ve heard of Warren Buffett, right?  Widely touted as the best stock market investor of all time.  Well, there are actually a few other investors that have achieved greater returns than Warren Buffett, believe it or not.  Including Jamie Simons, who has achieved returns of 62% p.a. according to Morningstar (https://www.morningstar.com.au/insights/personal-finance/247322/the-greatest-investor-youve-never-heard-of).  Warren Buffett has achieved an incredible, 19.8% p.a. according to investing.com: https://www.investing.com/analysis/why-warren-buffetts-198-annualized-returns-remain-unmatched-200639673).  Buffett and Simons both have extraordinary wealth – Buffett, at the time of writing (Oct 2024) has a net worth of around USD 144 BILLION.  Jamie Simons on the other hand has a paltry USD 31 BILLION!  But Jamie Simons has triple the returns of Buffett each year, how is Buffett so much wealthier?  Buffett started investing pre-teens, he’s had around 8 decades of investing!  And nearly all of those billions were made after he turned 50 (that’s good because your Sunshine Coast Wealth Management adviser, Mike Beal, is in his early 50’s, heh) – why has nearly all the wealth been made after 50?  Because of the magic of compounding really coming into effect.

Remember, have a play on our compound interest calculator: https://www.mikebealfp.com.au/compound-interest-calculator/

And of course remember to give the best wealth management team on the Sunshine Coast a call today!

Best wishes,

Mike Beal, Financial Planner, Sunshine Coast.