What Is Compound Interest and How Does It Build Wealth?

Compound interest is the most powerful force in wealth building, and understanding it deeply transforms how you think about time, money, and investing. Albert Einstein reportedly called it the eighth wonder of the world, and while the attribution may be apocryphal, the sentiment is mathematically correct.

The concept is deceptively simple: compound interest means earning returns on your returns. If you invest $10,000 at 10% annual return, after year one you have $11,000. In year two, you earn 10% on $11,000 -- not just on the original $10,000 -- giving you $12,100. The extra $100 seems trivial, but over decades this effect becomes staggering. After 30 years, that $10,000 becomes $174,494. After 40 years, it grows to $452,593. The original investment increased by 45 times, and the vast majority of that growth happened in the final decade.

This is the key insight that Warren Buffett understood earlier than almost anyone. Buffett made his first investment at age 11, but over 99% of his wealth was accumulated after his 50th birthday. This is not because he suddenly became a better investor in his 50s -- it is because compound interest is exponential, and the later years produce disproportionately larger returns. Buffett's net worth was approximately $19 million at age 52 and grew to over $100 billion by age 93. The compounding curve is flat for decades and then goes nearly vertical.

Charlie Munger describes compound interest as the investor's best friend if you give it enough time, and the investor's worst enemy if you interrupt it. Every time you sell an investment and pay taxes, you are resetting the compounding clock. Every time you withdraw from your retirement account early, you are not just losing the withdrawal amount -- you are losing decades of compound growth on that amount. This is why Munger and Buffett almost never sell their investments: the tax cost of selling interrupts the compounding process.

The Rule of 72 provides a quick way to understand compound interest. Divide 72 by your annual return rate to estimate how many years it takes to double your money. At 8% return, money doubles every 9 years. At 10%, every 7.2 years. At 12%, every 6 years. This means that $100,000 invested at 10% becomes $200,000 in 7 years, $400,000 in 14 years, $800,000 in 21 years, and $1.6 million in 28 years. Each doubling is bigger in absolute terms than all previous doublings combined.

The three variables that drive compound interest are: the amount invested, the rate of return, and time. Of these three, time is by far the most powerful because it is the exponent in the compound interest formula. Doubling your investment amount doubles your final wealth. Doubling your time horizon can multiply your wealth by 10x or more. This mathematical reality is why starting early matters so much more than investing more money later.

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The Bottom Line

The deepest lesson of compound interest is that wealth building is not about being clever -- it is about being consistent and patient over extraordinarily long periods.