Time in the market is more important than timing the market.

Albert Einstein once called compound interest the most powerful force in the universe. But what is it, and why is it so powerful?

Our next video in our Timeless Truths for Investing series will inspire you by showing you the increasing power that investing even modest amounts of money can have over long periods of time.

Read the Transcript:

Jason Myhre: “Remember the most powerful force in the universe. Believe it or not, the genius Albert Einstein once said this, the most powerful force in the universe is compound interest. I want to introduce this point to you by using a classic example. It’s called a very expensive cup of coffee.

If you’re the type of person that likes to purchase coffee out at your favorite coffee shop, chances are you’re spending about $3 on that coffee, that’s the national average. Let’s imagine instead of buying $3 in coffee, you decided to invest that amount. How much would you have after 40 years? If we assume the historical growth rate of the US stock market, it grows to more than $215,000–a very impressive amount of money. Given how little you’re investing, just $3 a day. Why does investing grow the way that it does? It’s because of something called compound interest. And I want to share with you a layman’s definition, this one comes from Benjamin Franklin. He defines compound interest this way, money makes money, and money that makes money makes money. So what we’re doing is we’re investing $3 a day instead of buying coffee. $3 a day times 365 days in a year is $1,095. That’s what goes into the account every single year. It’s growing by the growth rate, which is 6.7%. So that at the end of year one, you now have, as you can see, a little more than $1,100.

In year two, compound interest begins to kick in. So the first thing you do is you invest another $1,095. That’s just what you’re committed to doing, instead of buying that coffee. It gets added to what is already in the account, such that at the beginning of year two, you can see it’s about $2,100, and then the whole thing grows again by the growth rate and at the end of year two, you have about $2,400. All the following years look the same. Now, let’s walk through Benjamin Franklin’s definition here. He says money makes money. What he means is you’ve got some money in your pocket and then it makes money. How did that happen? You invested it. So he’s talking about the very first part of this, this breakdown here where that $1,095 becomes $1,100. So money makes money. Then he says, and the money that makes money starts to make more money.

What he means is you’re not actually taking anything out of the investment account, you’re reinvesting it, including the interest that was made the prior year, such that even the interest begins to make interest or it compounds, compounding interest. This is where we get that phrase from. Let me show you what this problem looks like if you chart it. The yellow line shows you what $3 a day looks like. The blue line shows you what $3 a day invested looks like, and what I want you to pay attention to here is the upward-sloping line. What starts out in the early years looking very humble in the later years starts to look really impressive. This is the reason why financial people in your life are always telling you to invest as early as you can because time is such a powerful force because of this compounding interest. When you’re an investor, be patient. Time is a great friend because of this powerful force of compound interest.”