For Gold, Peace, and Freedom


Figuring Compound Interest: Why Saving Is Important

May 26th, 2008

compound-interest-savings.jpgIn my earlier article on simple interest amortization schedules, we looked at how to figure out the monthly payments and total costs of paying down debts from loans on things like homes or automobiles. This short piece by Alexander Bond deals with the other side of the financial spectrum - why it is important to get into the habit of saving money instead of spending it all, and why Albert Einstein once mentioned that the most powerful force in the universe was compound interest.

Meanwhile, if you’re just looking for an easy way to calculate compound interest and play around with the numbers, this calculator page for savers from About.com will give you a good idea of how much interest you can earn over time with various rates and principal amounts.

According to legend, a Dutch trader named Peter Minuit bought the Island of Manhattan from the Lenape Native American Tribe for $24 worth of glass beads and other trinkets. On the surface, this seems like a bad deal for the Lenape; some would likely see it as an early form of predatory capitalism. But if we examine the situation more closely, we may find a different story.

If the Lenape tribe had invested their $24, earned a return of 6.25%, and did not take any withdrawals, they would have had $371.1 billion by the end of 2006. This growth rate on their investment actually ends up being greater than the value of the land they sold. In 2006, the New York City Department of Finance estimated the property value of all of Manhattan to be around $200 billion.

In modern investing, 6.25% is usually considered a rather low rate of return. It is equivalent to what the bond market is returning in recent years. What if the tribe had taken a slightly riskier investment strategy? Assuming an 8% return on investment, the tribe would have $151 trillion today. Maybe selling the Isle of Manhattan wasn’t such a bad deal after all!

Of course, the Lenape Indians did not have the financial tools and investment knowledge that we have today. You, however, can put the power of compound interest to work. Due to the miracle of compound interest, even tiny amounts of money can become large ones very quickly. If you can save even a modest amount of money and put this information to use in your retirement portfolio, you can eventually enjoy the benefits of having a comfortable nest egg.

2 Responses to “Figuring Compound Interest: Why Saving Is Important”

  1. comment number 1 by: Eric Shan

    Save money by saving your change can add up to thousands of dollars for your nest egg! That’s right, by taking the change you have in your pockets, purse, vehicle or anywhere you keep change, can help you to start saving money. Think about it, you can start saving your change today and you are guaranteed if you continue to save your change every day, that you will save a significant amount of money over time.

  2. comment number 2 by: Susan Phillips

    This site is very good for visualizing the benefits of compound interest. We’ve been using it in our maths classes with a lot of success. Hopefully we will end up with a generation of savers but i guess we’ll have to wait and see.

Post Your Comments, Opinions, or Suggestions Here:


Email (optional)

Website (optional)