The Power of Compound Interest

The Power of Compound Interest

The Power of Compound Interest Jonathan Poland

Traditional finance will explain compound interest as the interest paid on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. However, it is also the rate of return on an investment like a stock or real estate purchase.

Moneychimp Calculator

When interest is compounded on an investment, the interest earned in one period is added to the principal, so that the interest earned in the next period is based on a larger amount. The more frequently interest is compounded, the greater the amount of interest earned over a given period of time. For example, if an investment earns an annual interest rate of 5%, the interest earned in the first year is $50 on a $1,000 deposit. If interest is compounded annually, the deposit will be worth $1,050 at the end of the first year. If interest is compounded semi-annually, the deposit will be worth $1,025 after six months and $1,051.25 after one year.

Historically, home ownership has produced around 5% a year while the S&P 500 has generated around 10%. Over time, that 5% difference per year adds up to an incredible advantage for stock ownership over home ownership. Let’s just use the average mortgage term of 30 years at 5%. Let’s just say you pay cash for your house and it costs $300,000. In 30 years, with the historic compound interest rate at 5% for real estate, that home appreciates to $1.3 million. Do the same investment amount at 10% for an investment in the S&P 500 and that asset appreciates to $5.2 million. The difference is stark and significant. Let’s say you get 20% a year… that investment now becomes $71 million. Let’s say you get 30% a year… that investment now becomes worth $785 million. You get it.

There are a few key factors to consider when calculating compound interest:

  • Principal: The initial amount of money that is invested or borrowed.
  • Interest rate (or) Rate of Return: The percentage of the principal that is charged as interest.
  • Compounding frequency: How often the interest is added to the principal (e.g., annually, semi-annually, quarterly, monthly, daily, etc.).
  • Time: The length of time over which the interest is calculated.

In conclusion, Compound interest is the interest on interest, it can grow the investment at an exponential rate and can be favorable for both borrowers and savers. The calculation of compound interest depends on the principal, Interest rate, compounding frequency and time. There are many online calculators available to help with the calculation.

Learn More
Management by Exception Jonathan Poland

Management by Exception

Management by exception is a management technique that involves automating standard processes and empowering teams to handle routine business conditions.…

Managed Services Jonathan Poland

Managed Services

Managed services refer to a range of IT and business services that are outsourced to a third-party provider. These services…

Abundance Mentality Jonathan Poland

Abundance Mentality

Abundance mentality is the belief that there is enough for everyone and that abundance, rather than scarcity, is the natural…

Relational Capital Jonathan Poland

Relational Capital

Relational capital refers to the value that a company derives from its relationships with stakeholders, such as customers, employees, suppliers,…

BATNA Jonathan Poland


BATNA, or best alternative to a negotiated agreement, is the course of action that a party in a negotiation would…

Figure of Merit Jonathan Poland

Figure of Merit

A figure of merit (FOM) is a value used to evaluate the performance of a system or device. It is…

Examples of Products Jonathan Poland

Examples of Products

A product is something that has value and can be sold on a market. In order for a product to…

Camping Strategy Jonathan Poland

Camping Strategy

Camping strategy is the practice of a using a geographical location as a competitive advantage. It has several common applications:…

What is a Lifestyle Brand? Jonathan Poland

What is a Lifestyle Brand?

A lifestyle brand is a type of brand that is designed to appeal to a particular way of life or…

Search →
content database

Search my thinking on business, finance,
and the capital markets or start below

Variable Pricing Jonathan Poland

Variable Pricing

Variable pricing is a pricing strategy in which prices are set based on real-time data and can vary depending on…

External Risk Jonathan Poland

External Risk

An external risk is a type of risk that is outside of your control and cannot be influenced or managed…

Strategic Thinking Jonathan Poland

Strategic Thinking

Strategic thinking is the process of considering the long-term direction and needs of an organization, and developing plans and strategies…

Budget Variance Jonathan Poland

Budget Variance

Budget variance is the difference between the budgeted amount and the actual amount spent on a department, team, project, or…

What is Reliability? Jonathan Poland

What is Reliability?

Reliability is a measure of the ability of a product or service to perform consistently and predictably over time. It…

Quality Goals Jonathan Poland

Quality Goals

Quality goals are specific targets that are set to improve the quality of a product, service, or process. They are…

Risk 101 Jonathan Poland

Risk 101

Competitive advantages can spring from intellectual property, brand recognition, or even a company’s talent pool and whether protected by law…

Job Orientation Jonathan Poland

Job Orientation

Job orientation, also known as onboarding, is the process of introducing new employees to the company and their role. It…

Niche Market Jonathan Poland

Niche Market

A niche market is a small and specialized target market that is characterized by unique needs, preferences, and perceptions. These…