REFinBlog

When it comes to investing, compound interest really is the most powerful force in the universe. Remarkable in both its simplicity and its power, compound interest is the concept of reinvesting, along with the original principal sum, the interest earned on your investment.

As a result, you earn interest on top of interest, and then more on top of that larger sum, and so on. “Over time, a small amount of money can become a mountain of money,” says David Winters, CEO of Wintergreen Advisers.

Compound interest is one of the most basic concepts for investors to understand, in no small part because its magical results work the same whether you have $100 or $100 million.

In that sense, it’s every investor’s secret weapon – and you probably want to use your secret weapon if it can help you build your retirement nest egg (which it can). Unfortunately, if you look at how the average American spends and invests, it doesn’t reflect a great respect or understanding of compound interest.

It’s time to change that.

Proving its power in a thought experiment. David Reiss, professor of law at Brooklyn Law School, likes to convey the profound power of compound interest with a riddle of sorts.

“Would you rather receive a gift on Jan. 1 of $1 million, or a penny that doubles every day for the rest of the month?” Reiss says. “Most kids would go for the million bucks, but those who are patient enough to do the math know that they can get millions more if they are patient enough to wait the month.”

It’s true. The penny-doubler would in fact finish January with $9.7 million more than his or her instant gratification-seeking friend.