e = mc²

You don’t have to be a physicist to recognize this equation and immediately associate it with Albert Einstein. But did you know there is another equation that also holds an association with Albert Einstein?

A = P(1+r/n)^nt

Isn’t it beautiful? Well, maybe to the uninitiated the beauty of this equation is not readily apparent. Hopefully by the end of this article, you will recognize its beauty. This equation describes the concept of “compound interest,” how money grows when it is invested, given things like how much is invested (P), the investment return (r), and how long the money is invested (t).

Albert Einstein recognized the beauty of this equation when he said, “Compound interest is the eighth wonder of the world.”  Pretty high praise from somebody who knows a little something about math! But what he said next could change your life. “He who understands it, earns it. He who doesn’t, pays it.”

Let’s look at a super simple example that explains why Einstein thought so highly of compound interest. Assume you invest $1.00 at an annual rate of return of 10%. The table below shows how that dollar grows over eight years.

Year	Balance
0	$1.00
1	$1.10
2	$1.21
3	$1.33
4	$1.46
5	$1.61
6	$1.77
7	$1.95
8	$2.14

After one year, your $1.00 initial investment has earned 10% and become $1.10. Pretty straight forward. In the second year, however, an interesting thing happens. Your original dollar earns its 10% again, but the 10% your dollar earned in the first year, the ten cents, is still hanging around and it also earns 10%! Yes, just like a teenager, that ten cents expects an allowance just for existing! After several years of your initial investment earning interest and that interest earning interest, your account is just a bunch of teenagers standing around with their hands out.

By about the seventh year, through the power of compounding, the money your original dollar earned is now equal to, and earning just as much as, that original dollar. Where you had one dollar working for you, after seven years you now have two. Then in seven more years, that two dollars becomes four. Now imagine if, rather than $1, you were compounding $10,000 or even $100,000!

Unless you have them hidden under your mattress, every one of your dollars is always compounding; in a savings account, a 401(k), or a brokerage account. But, as Einstein’s quote suggests, compound interest can also work against you. Debt products also employ the concept of compound interest. Credit cards, car loans, and even so called “good debt” like mortgages and student loans leverage compound interest to the benefit of banks.

As of March 2023, the average credit card interest rate was 23.99%. Credit card balances don’t compound annually like the $1.00 example above. Interest on credit card balances is applied monthly. If you carry a credit card balance, you are compounding interest for the bank at about 2%…per month! When you recognize that credit card balances compound monthly at a rate of 23.99% annually, you begin to understand how banks can afford to build those skyscrapers in New York, Chicago, and LA.

With new insight into the concept of compound interest, your goal should be to rid your life of the bank’s teenagers and accumulate as many of your own financial teenagers as quickly as possible. To do this, create a plan to eliminate debt. The highest “investment” return you will likely ever generate is paying off your credit card balances. Then, once your debts are paid off, begin to invest for your future and put the power of the eighth wonder of the world to work for YOU!