Compound Interest

by: Mark J. Grant

Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it.

- Albert Einstein

There is nothing quite like it, compound interest. It is tantamount to a financial sprinkler system that keeps growing your money. It is funny, in a strange way, many people work very hard and do what they can to make money, but when it comes to growing what money they have accumulated, they are stymied.

Compound interest is proof of God's existence.

- Jeff Rich

The formula for annual compound interest, including the principal sum, is:

A = P (1 + r/n) (nt)
Where:
A = the future value of the investment/loan, including interest
P = the principal investment amount (the initial deposit)
r = the annual interest rate (decimal)
n = the number of times that interest is compounded per year
t = the number of years the money is invested for

Note that this formula gives you the future value of an investment, which is compound interest "plus" the principal.

Compound interest is the root, the very heart, of my "Cash Flow Investing" strategy. It is "making money on the money" and it is either a substitute for investing for appreciation or an alternative strategy utilized alongside it. I prefer monthly cash flow streams, if I can find them, which can be found in some of the closed-end funds that I like. Every month, "Here is the money."

My wealth has come from a combination of living in America, some lucky genes, and compound interest.

- Warren Buffett

There is also another important factor of monthly cash flows, from compound interest, which is often overlooked. This is the opportunities that it gives you, and the protection that it affords you. One is the flipside of the other.

The markets have, and can, and will, do strange things. Political events happen and economic events happen and surprises are always lurking in the shadows. Since you are receiving money each and every month, if you are receiving monthly payments, you are able to react to what might happen and this is a "huge plus," in my estimation.

If, as an example, you owned ten bond/equity closed-end funds or MLP funds, paying monthly, then each and every month you can look at your portfolio and decide which opportunity shines the brightest or you can add a new name, after you have done your homework. Here are twelve opportunities a year versus a standard bond which only offers two. On the flip side, monthly payments also offer twelve opportunities a year to protect your portfolio, if things go sideways, or worse, which is something you can count on happening over time.

I think people don't understand compound interest because typically no one ever explains it to them and the level of financial literacy in the U.S. is very low.

- James Surowiecki

The recent hoopla in the Press is about Bitcoin. You might as well be playing craps, in my estimation. A few will win many will lose, but of course, the same thing can be said about a casino. This is patently not what I consider to be investing, which is all that I have an interest in doing. Gambling is just not my game!

The markets are a combination of gambling, speculating and investing. I have interest in the last two categories and none in the first one. I am not saying that gambling is wrong but what I am saying is that you should understand exactly which you are doing when you lay your money down on the table.

Time is your friend, impulse is your enemy. Take advantage of compound interest and don't be captivated by the siren song of the market.

- Warren Buffett

Compound interest is a historically interesting concept. Compound interest was once regarded as the worst kind of usury and was severely condemned by Roman law and the common laws of many other countries. The Florentine merchant Francesco Balducci Pegolotti provided a table of compound interest in his book Pratica della mercatura published in about 1340. Richard Witt's book, Arithmeticall Questions, published in 1613, was a landmark in the history of compound interest. It was wholly devoted to the concept. Witt was a London mathematical practitioner and his book is worthy of note.

The more we progress the more we tend to progress. We advance not in arithmetical but in geometrical progression. We draw compound interest on the whole capital of knowledge and virtue which has been accumulated since the dawning of time.

- Sir Arthur Conan Doyle