Compounding: why time does the heavy lifting
Earning on your earlier earnings is the reason twenty years is not just double ten.
The simple arithmetic behind it
You put in €1,000 at 7% a year. After the first year you have €1,070. The second year does not earn 7% on €1,000, but on €1,070 — so €74.90 instead of €70. The difference is only five euros and looks like nothing.
But that difference feeds on itself. After ten years you have about €1,967. After twenty years, about €3,870. Twenty years did not give you double what ten years did — it gave you nearly four times the gain.
That is the whole idea: gains do not add up, they multiply. And the multiplication only becomes dramatic towards the end.
Why the end matters more than the beginning
If you invest for thirty years, more than half of the money at the end comes from the last ten years. Not because those years were better, but because in those years the amount doing the earning was bigger.
This has an uncomfortable practical consequence: stopping near the end costs far more than starting a year late. People feel it the other way around.
It also has a good one: you do not need spectacular returns. You need ordinary returns that never get interrupted.
The other side of the coin
Compounding works just as well against you. An annual fee of 1.5% does not cost you 1.5% — it costs you 1.5% repeated every year, on money that would have kept growing.
The same goes for inflation. If prices rise 3% a year, money under the mattress loses half its buying power in twenty-three years, without a single digit changing in the account.
That is why fees and inflation deserve the attention usually given to picking stocks. They work every year, unnoticed.
€10,000 at 7% a year
| After | Value | Earned during that decade |
|---|---|---|
| 10 years | €19,670 | €9,670 |
| 20 years | €38,700 | €19,030 |
| 30 years | €76,120 | €37,420 |
Key terms in this lesson
- Compounding
- Earning returns on your previous returns, not just on the amount you started with.
- Annualised return
- The steady yearly rate that would have produced the same final result.
- Real return
- Your return after inflation is stripped out — how much more you can actually buy.
Quick check
Why does a 1.5% annual fee cost you much more than 1.5% of your money over thirty years?
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