Compound interest explained
If I asked you for 10000 EUR and there was a 100% guarantee that I would give it back in one year, would you give it to me? Probably not. Even if you got it back what would be your benefit of giving me 10000 EUR?
What if I asked you for 10000 EUR. However, I would not give it back but instead I would keep it for you, for as long as you like and give you 7% in cash every year I have it for the rest of your life. Would you do it? Actually this time you might be persuaded to do it. You might think you would live another 30 years and so you would not only get your original 10000 EUR back, but also your additional investment.
And if I told you you could give me as much money if you liked? On whatever I give you I will give you back 7% every year. You are free to add money whenever you like.
It does get complex. It gets easier when we put it in visual. In this case you give me 10000 EUR and the 7% I give you every year you actually give back to me so I can give you more each year.
What we see is that after 25 years with just one contribution the money would have grown to 57.000 EUR that you can take back at any time. You would also be getting 3390 EUR of interest each year, almost your initial investment. Even more if you would wait another 25 years you would end up with a grant total of 327.000 EUR and 22.890 EUR a year.
You can see near the end how fast it starts to grow every year. The key is the faster you start with it the more profit you will gain.
You can accelerate this even more. Apart from your initial 10000 EUR, what if you would add 1000 EUR every month.
What we see now is that with just adding 1000 EUR every month after 25 years I now have 867.000 EUR and would be getting 60.690 EUR yearly interest. For a lot of people this is more then enough to live off every year. If you can continue to save for another 10 years you will be a multimillionaire reaching 1.9M EUR! The key? Start early! Get a student job from the age you are able to and invest whatever you can.
Even if you just deposit just 200 EUR every month, you will have 1M EUR, starting at age 16 by the time you reach official European Retirement age. Keep in mind most of that 1M EUR is pure compound interest. You didn’t had to do anything for this apart from investing! Key is the earlier you start the easier it will be, but remember its never to late to start. The best time to start was yesterday, but the second best is today!
7% will probably seem high for people that are used to keeping their money in their bank account and get an interest of 1% per year on the really good ones, however it is not. There is lots of investment methods where you can get this income: real estate (rentals + value increase of the property), peer to peer and also the stock market (by average the stock market grew 6,73% in the last 30 years). The only thing you can be sure of, if you leave your money on your bank account it will lose value. Additionally with all the discoveries waiting just around the corner, AI, self driving cars, green energy, job automation, huge medical discoveries, … can you really afford not to be in the stock market?
I know I have said this before, but its just crucial to know and believe this information.
I wish I knew what I know now 5 years ago, I was a really good and conservative saver, but not a good investor. If I had invested monthly without emotion right now I would be earning a massive amount of passive income every month.
How I plan to leverage compound interest
Lets examine my current situation, and find out when I could retire. As you know I am aiming for a 15% peer to peer and 85% ETF portfolio. Peer to peer is just to new to figure out how much it will make me in the long run, so for now I will base the income on 100% ETF situation with a return of 6.4% yearly, a bit lower then the market return but keeping in mind some minimal costs.
Lowering my retirement age using compound interest!
The official retirement age in Belgium is 67 years. From then on you will get a government pension. But of course nothing stops you to stop working earlier. Let’s find out when I could quit!
My pension at 67 years would also be slightly higher because I am buying off the years I studied as years worked! Something I highly recommend to do if you live in Belgium and are aiming for FIRE!
To calculate what is realistic I decided to calculate it for 3 windows: 10, 15 and 20 years.
Whats my current situation?
I currently have about 54.000 EUR in liquid investings (peer to peer and ETFs). I invest 2500 EUR every month (I don’t know if I will be able to keep up this amount, as I am looking for a house, but for the sake of the exercise I will assume I will).
Lucky ETFs are almost tax free in Belgium so a 6.4% is really safe to assume!
I also have one real estate property that I will talk about a bit later but that I will not include in this calculation.
After 10 years of compound interest investing..
If I manage to keep this up to 10 years I would have 520.000 EUR. This might be enough for a “lean FIRE”. To be honest I MIGHT be able to retire on this, but it would be very risky, because if there is a stock market crash right after I might not even be able to last until the official Belgian retirement age.
After 15 years of compound investing
After 15 years of compound investing I will have reached 893.000 EUR. I will be 50 years old by then. This would be a more safer path to retire and I really consider this a possibility. It should be enough to not only keep my lifestyle but should even continue to grow my investments
After 20 years of compound investing
After 20 years I will be 55 years old. This would be the absolute last date that I would want to be financially free! I would have 1.4M invested by then which would give me a really comfortable FIRE in Belgium, perhaps even what they would call a FAT FIRE. Additionally I would expect to live in a house that’s paid off by then. Currently the loan I pay off is lowering my savings rate.
I do own my own apartment. My plan is to buy a house and leverage the rent of my current apartment to contribute to my loan. This way I would be paying almost the same amount as I was before.
After 20 years I would actually have paid off the loan on the house, and all the rental income would go towards FI
If I would rent out my apartment today I would (after taxes and costs) earn about 470 EUR / month. With a 4% average rent increase yearly. Of course I would not actually have access to this rent until after 20 years.
|10 years||15 years||20 years|
|Rent per year||8340||10152||12348|
|Rent per month||695||846||1029|
It’s hard to include that for the time being, since I have not actually yet bought my house, but it could add to my retirement age being set at 50.
What are the advantages of FIRE in Belgium?
At the age of 67 you will get a government pension. Assuming I retire at 50 and I keep my current job and income I would get 1470 EUR income per month. Additionally the pension I have been saving for personally and the pension of my work would come free that I could re-invest in the stock market giving me more extra income.
Lastly medical costs are largely covered by the government although I could get an additional insurance for a very low fee (probably under 50 EUR per month), so I’m covered everywhere in Europe and even have a somewhat decent coverage worldwide!
So what is my Financial Independence age?
Its just to early to say right now. I know I am working in the right direction, but I want to wait for a few more things before I can really say: I want to have at least one house where I could see myself grow old, and I want to have a better view on my savings rate. My data is just to limited and I feel there is still places I can budget more.
Nobody knows what the future holds
I can’t really predict what will happen. I will meet someone at some point and have children, this will no doubt have impact on my target age. At the same time I might have a wage increase, or who knows a decrease if I decide to work less or change to a less fast paced job at some point. At the same time I will probably have a partner with an income as well if there are children that would make it easier to have more rental properties.
Also moving to another country might influence the retirement age. Thirty percent taxes on interests in Belgium is quite a high number. In Portugal you actually pay 0% the first 10 years.
Lastly taxes tend to change with the wind and are very unpredictable in Belgium. The tax climate could change overnight make it most likely more difficult to reach FIRE.
In any case doing this calculation gives me the strength to hold the course and transfer 2500 EUR to investments every month.
Writing this down will help me to track my progress, to see if I am doing better or worse then I predicted. Just remember until the time is there is important that you keep enjoying life. Its fine to be frugal but don’t be stingy! Still show your friends you care, go out and do activities, care about family and donate to charities. Do not stay hidden inside to save every penny, as then you will just watch your life go by and have no stories to tell when you finally do retire. Invest what you can and go on your roadtrip to Fire but don’t forget to enjoy every minute of the trip.
Now start to plan YOUR path to financial freedom!
I hope my roadtrip is also offering some perspective for yours. Let me know what your plans are for FIRE and check out the compound interest calculator here to calculate your roadtrip to financial freedom!
If you are interested to know more about how I end up then follow me and learn from my successes and mistakes on my Roadtrip to Financial Freedom!
4 thoughts on “How compound interest is fueling the road to Financial independence”
Excellent reminder about Compounded interest. One of my regrets is that I wasted a year’s salary on Forex in the early 10’s instead of investing it in ETFs. I missed quite some profits because of this. I hope I can still catch up by investing more aggressive, but I fear I will always be a bit behind. Using the calculator you link I missed on average (assuming 7% annually) 25K 😦
Yup we all made mistakes that’s normal but that’s how we learn. The only thing that is certain is that if you keep it on the bank you will lose money