Unlocking the Advantages of Compound Interest for Wealth Creation and Retirement Planning

Einstein's observation

The quote, 'Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it,' is often attributed to Albert Einstein. Regardless of the specific context of that quote, Einstein astutely cited the consequential power of compound interest in finance, investing, and economics.

Exponential growth

Compounding creates exponential growth. Interest-bearing financial products, such as savings accounts, CDs, or bonds, produce income based on a percentage of the capital invested in those products. Consider a $100,000 account that pays 5% interest each year. After the first year, there will be $105,000 in that account, and the 5% in the next year gets paid on a larger number. As the asset grows, so too does the amount of returns generated each year.

Compounding expense

Don't overlook Einstein's more ominous reference to people who pay compound interest. Unhealthy debt can wreak havoc on a financial plan. Incurring compound interest can have dire effects on a financial plan. Every dollar that goes out the door as interest can't be invested. If you pay compound interest, you have even fewer resources to benefit from compound interest. Make sure that you use credit responsibly.

The importance of starting early

The exponential curve underlines the importance of starting to save for retirement early. Every year that you delay saving for retirement removes one lucrative year from the back end of the curve. Start saving as early as possible, even if it's modest at first -- it can make a huge difference a few decades down the road.