Albert Einstein allegedly called compound interest "the eighth wonder of the world." Whether he said it or not, the idea is correct: compound interest is the phenomenon by which your returns generate more returns, creating an exponential growth effect. Understanding this changes the way you think about time and money — and explains why starting to save and invest today is more valuable than starting with twice as much money in five years.
With simple interest, you only earn on the original principal. If you have $1,000,000 at 10% per year for 10 years, you earn $100,000 each year = $1,000,000 in total interest. With compound interest, the interest from each period is added to the principal and generates additional returns. The same $1,000,000 at 10% annual compound interest over 10 years results in $2,593,742 — almost double the simple case. The difference is that money works on itself.
A quick way to estimate how long an investment takes to double is to divide 72 by the annual rate. At a 12% rate (typical of a long-term CD in Colombia), your money doubles in approximately 6 years. At 6% it doubles in 12 years. At the 24% rate of a credit card debt — which also works with compound interest, but against you — your debt doubles in just 3 years if you do not pay it down.
Imagine two people: Ana starts investing $200,000 per month at age 25 and stops at 35. Carlos starts at 35 and invests the same $200,000 until age 65. Both invest for 10 years, but at different periods in their lives. Assuming 10% per year, Ana ends up with more money at 65 than Carlos, despite having stopped contributing 30 years earlier. Time in the market beats money in the market.
The same effect that grows your savings grows your debts. A credit card with a 28% annual rate applied with compound interest on a balance of $2,000,000 that you only pay the minimum on can take more than 5 years to pay off, and you will have paid nearly three times the original value. That is why financial priority number one is eliminating high-cost debt before investing.