The Most Powerful Force in the Universe?

Albert Einstein is rumoured to have said that 'the most powerful force in the universe is compound interest'. That may seem a strange conclusion coming from a physicist who dedicated his life to unravelling the mysteries of the cosmos, but I believe he was certainly onto something.

The table below depicts what happens to $1000 when subjected to the force of compounding:

Nice table. But how does this relate to investing?

Well, firstly it should be clear that as the time period lengthens, the final result increases exponentially (this is evident by looking at the compound interest formula). So it is advisable to save and invest as early as possible. That 100 year milestone is only getting closer.

Secondly, take note that relatively small increases in the compound rate produce tremendous differences, particularly over long periods of time. This means that every percentage point counts when making investments.

So the secret to getting rich seems to be saving up money (or better yet inheriting a pile of cash), compounding it at a high rate and most importantly, staying alive. Easier said than done, but those that pull it off are handsomely rewarded.

If you look back at history (which is not a guarantee of the future), the Australian share market has produced quite satisfactory results over the long run, in the range of 10% pa depending on the selected timeframe. Any average Joe or plain Jane could have achieved this result by sticking their money into a low cost index fund and forgetting all about it until retirement.

And if you can do better than average, say an extra 5% pa over 50 years, you'll end up with over 9 times more cash than Joe. Personally, my goal is just this - to achieve at least a 5% advantage over the All Ordinaries Total Return index by investing in my spare time. If investing were my full time job, I think an extra 10% would be a good number to strive for.

Out of interest, I decided to extend the table and see what happens to a dollar over 1000 years. If you could invest it at just 5% pa, and your descendants had the mental fortitude not to splash out, eventually they'd be sitting on $1,546,318,920,731,950,000,000 - enough to buy everything produced in the world last year. More than 20 million times over.

Yes, I think Einstein had it right.

Please keep in mind that to simplify discussion, I have not taken into account the effects of inflation, taxes and fees on investment results, all of which detract from, but far from nullify the power of compound interest. Also, the example over 1000 years is purely theoretical, one would end up owning the world long before reaching such ridiculous sums.