"Compound interest is the eight wonder of the world." - Albert Einstein
The above quote leads off chapter two of Michael Moe's book. Although we learn about compound interest and the Rule of 72 in our high school math class, sometimes it takes some financial related calculations later in life to really drive the point home, enough so that it will have an effect on our saving and investment habits during adulthood.
Moe uses two compound interest examples that are worth repeating here. Although both cases are impossible to be recreated in the real world today, the dramatic numbers should at least intrigue people enough to run the numbers on their own individual financial plans. The results will still most likely be surprising for many of you.
• Purchase price for Manhattan Island in 1626 by Dutchman Peter Minuit: $24
• Value today if invested at 5.0% annual rate of return: $2.7 billion
• Value today if invested at 7.5% annual rate of return: $20.7 trillion
• Value today if invested at 10.0% annual rate of return: $128.7 quadrillion
You have landed a consulting job for the month of January. Your temporary employer has given you the option of earning $10,000 per week or earning $0.01 on the first day and having your daily pay double each day thereafter for the remainder of the month. Which payment plan should you choose?
• Earn $10,000 per week for the month = $40,000
• Earn $0.01 on first day, double every day = $21.5 million
While these examples are meant to be fantasy, not reality, compound interest is still a very important concept to consider when you are contemplating your saving and investing plans.