Compound Interest: The Numbers Behind "Start Early"
"Start saving early" is the most repeated piece of personal finance advice there is. It is also one of the least understood, because the word "early" rarely comes with the numbers that give it meaning. This article runs those numbers, so you can see the difference as plain arithmetic rather than a vague encouragement.
How Compounding Works
Compound interest means earning a return not only on the money you put in, but also on the returns you have already earned. In the first year you earn interest on your deposit. In the second year you earn interest on the deposit plus the first year's interest. By the tenth year, your return is earned on a balance that includes nine years of accumulated growth.
The formula is FV = P × (1 + r)t, where FV is the future value, P the starting amount, r the annual return and t the number of years. The exponent is what makes compounding accelerate: each additional year of growth is applied to a larger base than the year before.
The Cost of Waiting
Three people each invest €5,000 at the start of every year until they turn 65, and earn 7% a year. The only difference is when they begin:
| Saver | Starts at | Years invested | Total paid in | Balance at 65 |
|---|---|---|---|---|
| Early Emma | 25 | 40 | €200,000 | €1,068,000 |
| Middle Marcus | 35 | 30 | €150,000 | €505,000 |
| Late Lena | 45 | 20 | €100,000 | €219,000 |
Emma ends up with almost five times as much as Lena, although she paid in only twice as much. She has more than twice as much as Marcus, although she paid in only €50,000 more. The extra money does not come from saving more, but from giving the savings more time to grow.
Start Early, Then Stop
One of the most striking illustrations of compounding compares a short early effort with a long late one:
| Saver | Invests €5,000 a year | Total paid in | Balance at 65 (7%) |
|---|---|---|---|
| Early stopper | Ages 25–34 only (10 years) | €50,000 | €563,000 |
| Late starter | Ages 35–64 (30 years) | €150,000 | €505,000 |
The early stopper saves for only ten years and never adds another euro. The late starter saves for thirty years and pays in three times as much money. Yet at 65 the early stopper has more. Ten years of saving at the start, followed by thirty years of simply waiting, beats thirty years of steady effort that begins a decade later.
This is not a trick or an unusual case. It is the mathematics of compound growth, applied consistently.
What Return Should You Assume?
The examples use 7% a year. Broadly diversified global equity funds have historically returned roughly 7–9% a year before inflation over long periods, or about 5–7% after inflation, so 7% is a reasonable middle estimate rather than an optimistic one. The exact figure depends on the period, the market and the portfolio.
| Type of saving | Long-run return, roughly | Risk |
|---|---|---|
| Bank savings account | Follows the central bank rate, often 0–3% | Very low |
| Government bonds | 2–4% | Low |
| Balanced fund (about 60% shares, 40% bonds) | 5–6% | Medium |
| Global equity index fund | 7–9% (historical) | Medium to high |
These are long-run averages. In a single year, returns can be far higher or lower: share markets have had years of −40% as well as years of +30%. A long time horizon smooths out these swings, which is another reason to start early. A 25-year-old investing for 40 years can ride out crashes that would badly hurt someone investing for only five.
Monthly Saving Works the Same Way
The examples use yearly amounts, but most people save monthly. The result is almost the same, and slightly better, because monthly contributions start growing a little sooner. €417 a month is about €5,000 a year. A 25-year-old who automatically invests €417 every month until 65 at 7% a year ends up with about €1.09 million.
The Practical Takeaway
Compound interest really is as powerful as the cliché suggests, but the cliché rarely comes with the numbers. Now you have them. The most effective step most people in their twenties and early thirties can take for their long-term security is to start investing something, even a small amount, as soon as possible, in a diversified, low-cost fund rather than leaving everything in a savings account. The mathematics reward time and patience more than size or cleverness.