Why Every Teacher Should Understand Compound Interest
Albert Einstein is often credited with calling compound interest the "eighth wonder of the world."
It is something I wish we'd all been taught at school.
Compound interest is simply earning returns on your previous returns.
Imagine you invest £10,000.
If it grows by 7% in the first year, you now have £10,700.
The following year, you're no longer earning 7% on £10,000.
You're earning it on £10,700.
The year after that, you're earning returns on an even larger amount.
Your money starts to snowball.
At first it doesn't seem particularly exciting, but it really is!
After twenty or thirty years, it becomes remarkable.
One of the biggest lessons I've learned since I started investing in 2012 is that time is far more important than trying to find the "perfect" investment.
As Warren Buffet once said, 'Time in the market beats timing the market'. Meaning the longer your money is invested, the more chance of making good returns, rather than trying to wait for market downturns to invest.
Let's imagine two teachers.
Teacher A starts investing £250 per month at age 25.
Teacher B waits until they're 35 but doubles their contribution to £500 per month.
Who finishes with more?
Surprisingly, Teacher A often comes out ahead because those extra ten years of compounding are so valuable.
It's one of the reasons I encourage younger teachers to learn about investing early, even if they can only afford small monthly contributions. This is also why DC pensions, when young, have the potential to grow into meaningful pensions.
Rather than taking my word for it, have a play with an online compound interest calculator.
https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php
Try entering:
Then play around. Increase the investment by £100. Or reduce the investment period by five years. Or increase or decrease the expected return.
It's amazing how much difference small changes make over long periods.
One of my favourite things to do is show colleagues and pupils these calculators. It's often the moment when investing finally "clicks".
When many people hear the word "investing", they imagine watching stock prices all day or trying to pick the next Apple or Nvidia.
That's never really appealed to me as I don't know more than full time investment bankers, or don't have the insider knowledge.
Over the years I've found myself becoming more and more influenced by the Boglehead philosophy of investing.
The basic idea is very simple:
Own as much of the global stock market as possible.
Keep your costs low.
Invest regularly.
Ignore the noise.
Stay invested for decades.
I started investing in 2012. Like most people, I've made mistakes and learned plenty along the way. To start with I tried choosing particular stocks or particular indexes. I actually made some terrible decisions when dipping my toe into investing in 2008 (during the financial crisis), which put me off for a number of years.
What I've learned is that successful investing isn't about making brilliant decisions. it is just about consistency, low fees, and trackers funds.
It's not particularly exciting. (Well I think it is).
Before you leave this page, spend five minutes with a compound interest calculator.
Change the monthly contribution.
Change the number of years.
Change the expected return.
I think you'll come away with the same conclusion I did all those years ago.
Compound interest isn't magic.
It just feels like it.
This article is for educational purposes only and should not be considered financial advice. Investments can fall as well as rise, and you may get back less than you invest. Past performance is not a guide to future returns.