Compound Interest

The Story of Ben and Arthur

The classic investing story of Ben and Arthur helps explain the power of starting to invest early.  It’s about two friends, Ben and Arthur, who both want to save money for retirement.

Ben starts investing $2,000 every year from age 19 to 26, putting a total of $16,000 into the stock market.  Then he stops investing altogether.

Arthur, on the other hand, doesn’t start investing until age 27.  He invests $2,000 every year from age 27 to 65, putting a total of $78,000 into the stock market.

Now, here’s where it gets interesting.  Both Ben and Arthur earn a 10% annual return on their investments.  When they both reach age 65, Ben’s investment has grown to about $2.3 million, while Arthur’s investment has only grown to about $1.5 million.

Even though Arthur invested more money overall, Ben ended up with more money because he started investing earlier and let his money grow for a longer time.

This story teaches us that that it’s not about timing the market, it about time IN the market!  Starting to invest early and consistently can make a huge difference in the long run, thanks to the power of compound interest.

Help Me Understand Compound Interest

Imagine you have a magical piggy bank.

Imagine you start investing $20 each month in the S&P 500, a stock market index that tracks the performance of 500 really big companies in the United States.  Let’s assume an average annual return of 7%, which is roughly the historical average return of the stock market.

After 1 Year:  At the end of the first year, you’ve invested a total of $240 ($20/month x 12 months).  With a 7% return, your investment grows by $16.80 ($240 x 7%), bringing your total to $256.80.

After 5 Years:  After 5 years of consistent monthly investments, your total contributions amount to $1,200 ($20/month x 12 months x 5 years).  With compound interest, your investment grows exponentially.  Assuming a 7% annual return compounded monthly, your investment could grow to approximately $1,514.78.

After 10 Years:  By the end of 10 years, your total contributions reach $2,400 ($20/month x 12 months x 10 years).  With compound interest, your investment could grow to around $3,405.58.

After 20 Years:  After 20 years of regular monthly investments, your total contributions reach $4,800 ($20/month x 12 months x 20 years).  With compound interest, your investment could grow substantially to approximately $11,650.27.

After 30 Years:  After three decades of consistent monthly investments, your total contributions reach $7,200 ($20/month x 12 months x 30 years).  With compound interest working its magic, your investment could grow substantially to around $37,291.56, assuming an average annual return of 7%.

After 40 Years:  After four decades of disciplined investing, your total contributions amount to $9,600 ($20/month x 12 months x 40 years).  With the power of compound interest, your investment could soar to approximately $87,786.89.

After 50 Years:  Half a century of regular monthly investments brings your total contributions to $12,000 ($20/month x 12 months x 50 years).  With compound interest continuously compounding, your investment could grow impressively to about $210,462.75.

After 60 Years:  After six decades of steadfast investing, your total contributions reach $14,400 ($20/month x 12 months x 60 years).  With compound interest relentlessly at work, your investment could reach an astonishing approximately $485,529.18.

As you can see, even with small monthly contributions, the power of compound interest allows your investment to grow significantly over time.  The longer you stay invested and the earlier you start, the more pronounced the effects of compound interest become.