You can't produce a baby in one month by getting nine women pregnant—Warren Buffett
Starting to invest your money late in life is kind of like leaving for a trip on the highway an hour later than you were supposed to leave: no matter how fast you drive you will not make up for lost time.
To have $1 million by age 50, if you start investing at age 25 you need to invest $10,000 per year, at a 10 percent average annual rate of return, the historical annual average for stocks1 over the past century.
To have the same amount ($1 million) by age 50, if you start investing at age 40 you need to invest—$60,000—per year at the same average annual rate of return. Or, if you want to invest just $10,000 per year starting at age 40 and still have $1 million by age 50 you need to earn an average annual rate of return of—41 percent. Basically impossible.
Making up for lost time is tough—in driving and investing.
Snowball
Investing your money is kind of like rolling a sticky snowball down a long hill. The stickier the snow, and the longer the hill, the bigger the snowball will grow. You’ve just got to get it started, and give it time to grow.
If you invest $10,000 per year at a 10 percent average annual rate of return, here’s how much that money will grow to over time:
10 years: $175,000
15 years: $350,000
20 years: $630,000
25 years: $1 million
And if you keep doing it for longer:
30 years: $1.8 million
35 years: $3 million
Notice how it builds.
Andrew Tobias, author of The Only Investment Guide You’ll Ever Need, said:
The prime thing to note is the importance of starting early . . . It is the early contributions that, compounded over time, grow enormously.”
Compounding starts slow then builds fast.
Your snowball picks up a pittance of snow at first then turns into a full-blown bolder.
That’s how compound interest works. With time it builds force.
The secret ingredient is time.
The Most Powerful Force
Einstein knew how powerful compound interest is. That’s why he called it “the most powerful force in the universe.”
Small things can grow really large over time, even at modest rates of return.
A single $100,000 investment grows to the following amounts over time, at a 5 percent compound average annual rate of return:
20 years: $265,000
40 years: $704,000
60 years: $1.9 million
80 years: $5 million
100 years: $13 million
It doesn’t take much. Just time.
Things compound dramatically—given enough time.
Two-Million-Dollar Haircut
To illustrate just how powerful compound interest is, take this extreme example:
Warren Buffett has earned an average rate of return on his investments of about 20 percent per year over his investment career.
Had Buffett, in 1956 when he was starting his career, skipped a $10 haircut and instead invested that $10, today that money would be worth—$2 million ($10 invested at a 20 percent average compound annual rate of return for 67 years).
That’s the power of time.
Wealth-Explosion
Time is so important in investing, to use Buffett as a further example, here’s how much of his wealth has come after his 50th birthday: 99 percent2.
Compound interest starts slow and then builds fast.
It’s power is not appreciated until it hits you in the face.
This is what physicist Albert Bartlett meant when he said, “The greatest shortcoming of the human race is our inability to understand the exponential function.
It's difficult to understand because it isn't intuitive.
Compound interest is exponential. It’s a geometric explosion. It gains force with time.
Like a snowball rolling down a hill. Soon it’s a bolder.
Jeremy C. Miller, in Warren Buffett’s Ground Rules, explained it like this:
At its very root, an investment program is first and foremost a compounding program. It is in the process of continually reinvesting gains such that each subsequent addition begins earning a return itself. These gains on gains become an increasingly dominant component of an investment program’s total returns over time . . . Compounding derives its power from its parabolic nature, the longer it goes, the more impactful it becomes.
Bottom Line
Hop on the highway early.
Get the snowball rolling early.
Compound interest works with time.
It’s the secret ingredient in building wealth and achieving financial freedom.
The S&P 500; it actually averaged 10.5% per year from 1924 to 2023