How Does Compound Interest Work with Stocks or 401k?

Posted by Grace under Investing on August 23, 2015

Do you want to know how does compound interest work with stocks, 401k, loans, mortgage, or credit cards? Many of us are wondering why do rich people are getting richer. The answer is “compound interest”. But, do you know how does a compound interest work? In financial terms, a compound interest is an interest gained added to the original investment or loan.

It is a fact that a young man has an advantage in using compound interest because the longer years the money was invested the better. Young men however, don’t use the benefits of compound interest in investing, instead, they will use it in “debts” such as credit card, loans, etc.

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Today, let just find out how this “scientific” and “simple mathematics” thing work. Albert Einstein once said;
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”, if you asked me I will use the effects of compound interest in investing rather than in debts such as credit card debts.

Example of Compounding Interest with Stocks or 401k?

In this example, we invest $10,000 (ten thousand dollars) in an investment vehicle that earns 15% per year within 20 years and here’s the effect of compounding our profits;

No. Contribution Interest Future Value Present Value
1 10,000 1,500 11,500 11,500
2 10,000 3,225 13,225 13,225
3 10,000 5,208 15,208 15,208
4 10,000 7,490 17,490 17,490
5 10,000 10,113 20,113 20,113

Note: In 401k and stocks, 15% is not the ideal or average return! Tr to calculate using 7% annually!

Related: Average Return in Stock Market Investing

The future value of 10,000 dollars that earns 15% within 20 years is amounting to $163, 665.37 (the money grew overtime because we compound the interest). If we will not use compounding the $10,000 in 20 years is only amounting to $40,000. It’s a big difference.

See Also: Compound Interest Calculator with Inflation Adjustment

I hope you will use compound interest in making money not losing money. In stock and 401k, you are making money, but using compound interest for debts like credit cards, think!

 

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