The part people underestimate
Compounding is not intuitive, because human intuition is linear and compounding is not. The standard illustration is worth working through.
At 7% a year, $500 a month for 30 years reaches about $566,000. The same $500 a month for 25 years reaches about $379,000. Five years of delay costs roughly $187,000 — even though only $30,000 of contributions were skipped. The missing $157,000 is growth that never had time to happen.
This is why the single most valuable input is not the return you achieve but the number of years you give it. Chasing an extra percentage point of return is difficult, risky and uncertain. Starting five years earlier is neither.
Contributions versus growth
Watch the crossover point on the chart. Early on, almost all of your balance is money you deposited — growth is a thin sliver on top. Somewhere between years twelve and eighteen for typical assumptions, the growth portion overtakes the contributed portion, and from then on the account is doing more work than you are.
Most people give up before reaching that crossover, which is the real reason long-run investing underperforms its own arithmetic.
Be careful with the return assumption
Small changes compound into enormous differences. Over 30 years, the gap between a 5% and a 9% assumption on the same contributions is roughly three times the final balance. Because the output is so sensitive, treat the result as a range rather than a forecast: run it at 5%, at 7% and at 9%, and plan against the pessimistic one.
Returns also do not arrive smoothly. A portfolio averaging 7% may fall 30% in a single year. The formula assumes a constant rate, which no real market provides.
Frequently asked questions
What is compound interest?
Compound interest is interest earned on interest already earned. Instead of returning a flat amount each year, the balance grows on a curve, because each year's return is calculated on a larger base than the last.
What annual return should I assume?
Long-run global equity returns have historically averaged roughly 7% a year above inflation, with severe multi-year drawdowns along the way. Cash and bonds return far less. Planning with a lower assumption than you expect produces a more robust plan than planning with an optimistic one.
Does compounding frequency make much difference?
Less than most people expect. On a 7% return, moving from annual to monthly compounding adds roughly 0.23 percentage points of effective annual return. The size and consistency of your contributions matter far more than the frequency.
Why does the calculator show a value in today's money?
Because a balance thirty years out is quoted in future currency, which buys less. Discounting by your inflation assumption converts it back into purchasing power you can actually reason about. It is usually a sobering number, and a more honest one.