The RetireMentors

Retirement advice from experts in the business

Oct. 28, 2015, 7:02 a.m. EDT

Another one Einstein got right: Compound interest

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By Paul A. Merriman

About Paul

Paul Merriman is committed to educating people of all ages to get the most from their retirement investments. Founder of Merriman Wealth Management, a Seattle-based investment advisory firm, he is the author of numerous books on investing: "Financial Fitness Forever," "Live It Up Without Outliving Your Money," and the new "How To Invest" series, free at his website:  "How To Invest" series: "First Time Investor," "Get Smart or Get Screwed: How to Select the Best and Get the Most from Your Financial Advisor" and "101 Investment Decisions Guaranteed to Change Your Financial Future." In his retirement, Paul writes a weekly column at MarketWatch and continues his weekly podcast, Sound Investing, which was recognized by Money magazine as "the best Money Podcast in 2008". He is president of The Merriman Financial Education Foundation and all profits from the sale of his books are used to advance financial literacy. His recommendations for portfolios of Vanguard funds, Fidelity funds and ETFs, podcasts, articles and books are available at Follow Paul on Twitter @SavvyInvestorPM.

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Albert Einstein famously cited compound interest as one of the wonders of the world, and thousands of articles and books have been written on that topic over the years.

This time I'm taking a slightly different approach. I want to give you some examples that should be highly relevant to all investors. In a follow-up column, I will show how you can make these numbers work for you, no matter what your age.

In a second follow-up piece, I will discuss how you can turn some of this information into amazing results for a child, a grandchild or some other young person. Because Einstein was right. Again.

Time is the pearl

The basis of all this is compound interest, which as you know combines growth with time. The more growth, the higher is the ultimate reward. The more time, the higher the ultimate reward. Time, as we shall see, is the real pearl.

From an investor's point of view, let's start with the modest long-term growth rate of 4%. Actually, this is a fairly conservative estimate for bond investors. Since 1928, long-term corporate bonds have compounded at 6.1%; U.S. government bonds have compounded at 5.7%.

Growth of 4% won't set the world on fire, at least not quickly. If you start with $1,000 (I'll use that figure in all of my examples in this column), after 20 years your money will slightly more than double, to $2,191. If you double the period to 40 years, that initial $1,000 grows to $4,801.

In the following table you'll find those numbers plus the results for three longer periods.

Growth of $1,000 at 4%

Years Ending value
20 $2,191
40 $4,801
60 $10,520
80 $23,050
100 $50,505

I believe that most investors with a really-long-term view will be willing to take on some additional risk in order to seek more growth than that. Depending on its allocation between bonds and equities, a balanced portfolio with proper equity diversification should provide long-term growth in the range of 6% to 8%.

Let's see what that would do over time with a series of comparisons. As you'll see, the difference between 6% and 8% gets much more dramatic over longer periods.

Growth of $1,000 over 20 years at 6% and 8%

6% return $3,207
8% return $4,661

Growth of $1,000 over 40 years at 6% and 8%

6% return $10,286
8% return $21,725

Growth of $1,000 over 60 years at 6% and 8%

6% return $32,988
8% return $101,257

Growth of $1,000 over 80 years at 6% and 8%

6% return $105,706
8% return $477,594

Growth of $1,000 over 100 years at 6% and 8%

6% return $339,302
8% return $2,199,761

Remember, those long-term results come from an allocation with only moderate levels of risk.

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