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The power of compounding

Albert Einstein considered compound interest one of the most powerful forces in the universe. That’s because things can scale incredibly well with enough time and steady growth. However, the starting base is often an overlooked factor that has major implications for compounding wealth.

Let’s take an example. Liam and Amelia have both spotted an investment opportunity that can deliver 8% in compounded annual returns for 20 years. However, Liam has $100,000 in capital ready to deploy right away and Amelia has nothing. Here’s how their paths will diverge.

  • Liam deploys his startup capital ($100,000) right away. By year 10, his investment has ballooned to $215,892. Liam hasn’t even lifted a finger yet. In year 20, Liam finally makes a move and sells his investment, which is now worth $466,095. His total return is 466%.

  • Amelia seeks out a job to start building some capital. She saves a portion of her income every year but it takes a lot of sacrifices and penny pinching. Amelia has to work extra hours, cut back on vacations and buy cheaper clothes. By year 10, she finally has $100,000 ready to deploy in this opportunity. Her investment earns 8%, same as Liam, for the remaining 10 years. She pockets $215,892 when she sells in the 20th year. Her total return is 216%.

Not only was Amelia’s journey tougher, but her total return was less than half of Liam’s. Both investors had the same opportunity and displayed the same level of patience. The only difference was the starting point.

For the first 10 years of their journey, Amelia saw no compound interest. Meanwhile, Liam earned money not only on his initial investment but also the interest earned every year along the way. That made all the difference.

With this in mind, accumulating startup capital should be an investor’s top priority. You need to make sacrifices, save every cent and carefully avoid losses to put yourself in a position to benefit from compounding.

More: How to calculate (and increase) your net worth

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Vishesh Raisinghani Freelance Writer

Vishesh Raisinghani is a freelance contributor at MoneyWise. He has been writing about financial markets and economics since 2014 - having covered family offices, private equity, real estate, cryptocurrencies, and tech stocks over that period. His work has appeared in Seeking Alpha, Motley Fool Canada, Motley Fool UK, Mergers & Acquisitions, National Post, Financial Post, and Yahoo Canada.

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