Compound interest is the strongest force in the financial world.
It’s why houses cost twice as much as the purchase price over the course of the loan.
It’s why you shouldn’t build up a debt on a high interest credit card from a bank like Commonwealth Bank of Australia (ASX: CBA).
It’s why genius scientist Albert Einstein (supposedly) once said that compound is “The eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
Property spruikers claim that property doubles every 10 years. You might think that means a property is gaining 10% a year from the first year to the tenth year. But in compounding terms it only equates to 7.2% a year, which is still a very good result.
Meanwhile, shares have returned around 10% a year over the long-term. So, a $1 million house becomes worth just over $2 million over a decade. But a $1 million share portfolio (not including taxes and franking credits) is worth almost $2.6 million after 10 years growing at 10% a year.
After 20 years, the difference between shares and property is even bigger, the share portfolio would be worth $6.7 million and the property would be worth $4 million (assuming “property doubles every 10 years”, when wages haven’t been and aren’t growing that fast).
If you’re thinking that these numbers are too big and don’t apply to you, then think again. If you can get together $1,000 a month to invest in shares over 20 years, you’d have a portfolio worth almost $700,000.
Shares are even better if you can find the ones that grow your wealth faster than 10% a year. Perhaps Altium Limited (ASX: ALU), REA Group Limited (ASX: REA) and MFF Capital Investments Ltd (ASX: MFF) will continue to be strong outperformers compared to a benchmark of 10% a year?
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Tristan Harrison owns shares of Altium and Magellan Flagship Fund Ltd. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Altium. The Motley Fool Australia has recommended REA Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.