Long-term investing is one path people may consider when building wealth. A key concept is “compound interest,” sometimes called the “Eighth Wonder of the World.” Compounding can allow money to grow over time as returns are reinvested. This article explains the concept and presents three investing principles that the source attributes to Warren Buffett.
What is compound interest?
You may have heard the term “compound interest” without knowing exactly what it means. Compounding can matter in long-term investing because reinvested returns may contribute to later growth.
How compounding works
Compound interest means reinvesting returns, such as interest on a deposit or gains from investments. The returns are added to the principal. In a later period, returns may be earned on the larger amount, which includes both the original principal and earlier returns.
For example, if you invest 100 baht and earn 10 baht in the first year, you have 110 baht. In the next year, a return is calculated on 110 baht, which may produce more than the first year’s 10 baht. Over time, this process can cause the invested amount to grow.
Compound interest versus simple interest
The main difference is the amount used to calculate returns. Simple interest is calculated only on the principal, while compound interest is calculated on the principal plus returns earned in previous periods.
For a simple example, suppose you deposit 100 baht into a savings account paying 5% a year:
- Simple interest: You receive 5 baht a year, regardless of how long you leave the money in the account.
- Compound interest: In the first year, you receive 5 baht and have 105 baht in total. In the next year, 5% is calculated on 105 baht, so the interest is more than 5 baht and the balance can continue to grow.
Over a long period, compound interest can produce more than simple interest under the same rate assumption.
Examples of compound-interest calculations
Here are examples to illustrate how compounding may work.
Compounded and non-compounded returns compared
Suppose you start with 10,000 baht and earn a 10% return each year.
- Without compounding: You earn 1,000 baht a year. After 40 years, the total would be 50,000 baht (10,000 baht principal plus 40,000 baht in returns).
- With compounding: The 10,000 baht grows over time and would become about 450,000 baht after 40 years.
This example illustrates how the results may differ when returns are reinvested. It assumes a steady 10% annual return and does not account for fees, taxes, inflation, or periods of loss.
How the investment period affects returns
The length of time invested can have a substantial effect on a compound-growth calculation. The longer the investment period, the more time there is for returns to accumulate.
Consider the same example over 50 years instead:
- With compounding: The 10,000 baht would grow to about 1,000,000 baht.
This example shows how adding ten years to the assumed period can greatly change the calculated amount. Actual investment returns are not fixed and may be lower or negative.
Three investing principles the article attributes to Warren Buffett
Warren Buffett is a well-known long-term investor. The source article presents three principles for applying compounding to investing.
Principle 1: Start as early as possible
As described above, time can matter in a compound-growth calculation. Starting earlier gives money more time to potentially grow.
If you intend to invest, the source encourages beginning today, even with a small amount, so you have more time to benefit from compounding. Any investment decision should still account for your needs, time horizon, and ability to absorb losses.
Principle 2: Invest consistently
Consistency is another factor the source identifies as important. Regular investing means contributing similar amounts over time regardless of whether the stock market rises or falls.
The source says regular investing can help you:
- Buy at an average price: You may buy at higher prices when the market rises and at lower prices when it falls, resulting in an average purchase price.
- Build investing discipline: A regular schedule may help establish a habit and avoid reacting to every market move.
- Continue compounding: Regular contributions may give more money an opportunity to participate in future returns, which are not guaranteed.
Principle 3: Protect your principal
The article emphasizes protecting principal because losing money reduces the base available to earn future returns.
It suggests that you:
- Choose assets that match your risk tolerance: Avoid taking on more risk than you understand or can accept.
- Diversify: Avoid placing all your money in one type of asset; spreading investments may reduce concentration risk.
- Research before investing: Understand the asset and seek qualified advice if you are uncertain.
The source article says these three principles can help investors use compounding and turn ten thousand into a million. This is an illustrative headline and not a guaranteed result.
Compounding is a useful concept for understanding how reinvested returns may accumulate. The article’s three principles are to start early, invest consistently, and protect principal. Investment values can fall, and no return is guaranteed.
💬 Get free financial-planning guidance at https://lin.ee/r7Ye9Gs
💬 Get free financial-planning guidance. Add us on LINE.
👉 Add us on LINE for a free consultationOr scan the QR code to add us.
