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The investor who started at 15 contributes $339,000 total by age 70. Why is their investment worth $3,286,310 - almost ten times their contributions?

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Final answer:

The investor's investment is worth almost ten times their contributions due to compound interest. The formula for compound interest is Final Amount = Principal x (1 + Interest Rate)^Number of Periods. Using this formula, the investment of $339,000 contributed over 55 years grew to $3,286,310.

Step-by-step explanation:

The investor's investment is worth almost ten times their contributions because of compound interest. Compound interest is the interest earned on both the original investment and any accumulated interest from previous periods. In this case, the investor started saving at age 15 and contributed a total of $339,000 by age 70. Over this period, the investment earned a real annual rate of return of 7% above the rate of inflation. The formula for compound interest is:

Final Amount = Principal x (1 + Interest Rate)Number of Periods

Using this formula, we can calculate the final amount of the investment:

$339,000 x (1 + 0.07)55 = $3,286,310

Therefore, the investment is worth $3,286,310 - almost ten times the initial contributions.

User Blackchestnut
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4 votes

Final answer:

The investor's contributions grow to almost ten times their original amount due to the power of compound interest. Compound interest allows both the initial principal and the accumulated interest to earn more interest over time, resulting in exponential growth of the investment, especially with consistent contributions and a good annual rate of return.

Step-by-step explanation:

The question is related to the concept of compound interest, which is pivotal in understanding how investments grow over time. Compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. In the scenario where an investor starts contributing at age 15 and continues until they are 70, contributing a total of $339,000, the reason their investment is worth nearly ten times their contributions at $3,286,310 is due to the power of compound interest.

When money is invested, especially in a well-diversified stock portfolio, it is common to expect a real annual rate of return of around 7%, which is above the inflation rate. This means that not only is the money making interest each year, but that interest is then used to generate more interest the following year. This snowball effect greatly multiplies the value of the initial investment over the long term.

For example, starting with a single investment of $3,000 at a 7% annual rate of return and letting it compound for 40 years without any additional contributions would result in the investment growing to $44,923. With continuous annual contributions and the same compound interest, the result is an even more substantial increase, leading to an eventual wealth that places the individual well within the top 10% of American households in terms of net worth.

User Jet Blue
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