The world's greatest invention

The world's greatest invention

(from Alvin Tabanag)

The genius Albert Einstein, who was named by Time magazine as the “Man of the 20th Century,” was believed to have called it “the greatest invention of mankind” and “the most powerful force in the universe.” You would think he was talking about a spaceship that could take man to another galaxy or Superman come to life. He was actually referring to “compound interest.” Whether Einstein really made those remarks or not is not important because compound interest is indeed a powerful force when it comes to savings and building wealth.

Many people do not understand or underestimate the enormous power of compound interests. This lack of understanding of its value in wealth building is one of the reasons why people are impatient and not motivated to save. Compound interest can be defined simply as “interest earned on interest.” To see how compounding works, try to solve the word problem below.

You have an investment of P100,000 that earns 10% interest per year.
How much money will you have at the end of 10 years?

Those who are not familiar with compound interests will probably compute it this way:

P200,000 would be the correct answer if you use ‘simple interest’ in the computation. But thanks to compounding your money will actually be P259,374 after 10 years. The total interest earned is P159,374 instead of just P100,000. This is because the interest earned each year will also earn interest in the succeeding years. Hindi lang ang original amount na P100,000 ang tumutubo sa mga sumusunod na taon kundi pati yung kinita na interest.

The table below shows how the original P100,000 principal grows each year if you do not withdraw the interest. Notice that the interest earned every year is increasing and not fixed at P10,000. Ito ay dahil dumadagdag ang interest sa prinsipal taun-taon at sa lumalaking prinsipal kinukuha ang 10% interest, hindi sa P100,000.

Why should compounding be of interest to you? Because it makes your money grow faster. The difference in growth after 10 years may not seem very significant. However, if you let compounding work its magic for a longer time, the difference will be very big.

Look at the chart below which shows the growth of P100,000 using simple interest and compound interest. In the first 10 years the difference is not that significant based on the columns. However, starting on the 15th year the disparity is becoming more evident. By the 40th year, the difference is staggering: P4.5M against P500T.

Accumulating a sufficient amount of funds to ensure your financial stability takes time. Sa simula medyo mabagal ang paglaki ng iyong ipon, pero kalaunan makikita mo na pabilis ng pabilis ang paglaki nito. So, start saving early. The earlier you begin, the more time compounding can make you more money. Every moment you delay, you lose the opportunity to earn more. As the old saying goes, “time is money;” and as you have seen, with compound interest, its lots of money.