Einstein is frequently misquoted as saying *“The most powerful force in the universe is compound interest”*. Einstein may not have actually said this but he was well aware of the benefits.

When it comes to successful long-term investing, compound interest is possibly the most important concept you need to understand. Compound interest is when you earn interest on top of interest. For example if you invest $1,000 in an account with an average yearly interest rate of 10%. After one year you will have $1,100 in the account. Now you would expect that after two years your account value would increase to $1,200. However, you would be wrong. The 10% interest is actually applied to the $1,100 you have in the account. Therefore, you will actually have $1,210 after two years.

Compound interest benefits the long-term investor. Therefore, if you leave that money in an account earning 10% interest each year for 30 years your investment will have grown to $17,449. That’s over 17 times more than you physically put in! Click here to calculate

If the above figures were not surprising enough, below is how $1,000 would grow, if it was saved at different interest rates over different periods of time.

5% interest rate:

- 5 years= $1,276
- 10 years = $1,629
- 25 years = $3,386
- 50 years = $11,468

10% interest rate:

- 5 years= $1,611
- 10 years = $2,594
- 25 years = $10,835
- 50 years = $117,391

15% interest rate:

- 5 years= $2,011
- 10 years = $4,046
- 25 years = $32,919
- 50 years = $1,083,658

The figures above show that over the first 5 years the different interest rates do not create a huge difference in returns. In fact the difference in return between the 5% and 15% interest rate is just $735. However, the longer you invest the greater the returns and the greater the effect of the interest rate. So after 50 years the difference in returns between a 5% and a 15% interest rate is over $1,000,000! This is the power of compounding.

Now, I bet you’re thinking “That’s great, but no bank account pays a compound interest rate of 10% let alone 15%” and if I had a Dollar for every person that thinks this I would already be a very rich man. The point is – *yes you will struggle to find a bank account that pays this much interest*, therefore you may need to be a bit more creative in what you invest in. To do this I recommend you speak to a qualified financial adviser.

Others may raise the issue of inflation. Inflation can be defined as the gradual rise in prices over time. It is why a Mars Bar now costs $1 instead of the 50 cents 15 years ago. Inflation is often overlooked by fans of Compound Interest, *perhaps this is because they just want to hear the good news*, the fact is though it cannot be ignored and must be taken into account.

So what would have happened to the $1,000 example above if we had an interest rate of 10% and an inflation rate of 3.7% (this is the USA 30 year average between 1980 and 2009). The good news is, you would still have $17,449 in the account after 30 years. However, in terms of purchasing power it would only buy you the equivalent of $5,870 today. This is what economists refer to as the Real Value.