How compound interest works
Compound interest is earning returns on your returns. In year one, a $10,000 investment at 7% grows to $10,700. In year two, the 7% applies to $10,700 — producing $749 rather than $700. The difference seems small, but over decades it becomes enormous.
- $10,000 at 7% → $19,672 after 10 years
- $10,000 at 7% → $38,697 after 20 years
- $10,000 at 7% → $76,123 after 30 years
No additional contributions. The Rule of 72 is a useful shortcut: divide 72 by your interest rate to estimate the years to double. At 7%, money doubles roughly every 10 years. At 10%, every 7.2 years.
Why starting early matters more than investing more later
A 25-year-old who invests $5,000 per year for 10 years (total: $50,000) and then stops will often end up with more money at 65 than a 35-year-old who invests $5,000 per year for 30 years (total: $150,000) — because the early investor gets 40 years of compounding instead of 30. The 10-year head start is worth more than 3x the contributions.
This is the fundamental argument for starting your FIRE savings as early as possible, even at a modest level. Every year of delay shrinks your compounding runway.
Index funds and compound growth
The most accessible way to capture compound growth is through low-cost index funds. A total market index fund reinvests dividends automatically, compounds across thousands of companies, and charges minimal fees. A 0.05% expense ratio vs a 1% expense ratio on a $500,000 portfolio over 20 years is a difference of over $100,000 in ending wealth, purely from reduced fee drag on compounding.
Compounding works against you too
Compound interest accelerates debt in the same way. A credit card balance at 20% annual interest compounds just as relentlessly as a stock portfolio at 7%. Paying off high-interest debt is a guaranteed compound return equal to the interest rate — which typically beats expected market returns on a risk-adjusted basis.
Practical implications for FIRE planning
The core disciplines for maximising compound growth:
- Stay invested through downturns — missing the 10 best market days in a decade typically cuts long-run returns by 30–50%.
- Reinvest dividends automatically via index funds rather than taking cash.
- Minimise fee drag — a 1% expense ratio versus 0.05% costs over $100,000 on a $500,000 portfolio over 20 years.
- Pay off high-interest debt before investing aggressively — guaranteed return equal to the interest rate.
- Start as early as possible — time in market beats timing the market, always.