Abu Dhabi, UAEFriday 6 December 2019

How to turn $10,000 into $1 million thanks to the magic of compound interest

Anyone can turn a small amount into a large sum of money, they just need plenty of time

Illustration by Gary Clement
Illustration by Gary Clement

Did you hear the story about how $1.22 million (Dh4.48m) turned into $42.74m?

It has all the ingredients of a blockbuster; politics, feuds, royalty and eccentric lives lived. It has gone on for decades and as of last week, has been resolved — in part — where the next step is working out who gets what bit of it.

Our working lifespans a few decades, so stashing money away for 35 years is a reasonable scenario. It would take you to your mid 50s if you started at 20.

Nima Abu Wardeh

Seventy years ago, the last Nizam, or ruler, of Hyderabad, Mir Osman Ali Khan, transferred $1.22m to Pakistan’s embassy in the UK for safekeeping. The Muslim monarch was resisting the incorporation of his state into Hindu-dominated India. A few days ago, the high court in London handed down a 140-page ruling that entitles the descendants of the last Nizam of Hyderabad to the money.

Politics aside though, let’s focus on the other matter in hand — how the money ballooned to $42.74m.

There are two key ingredients here: it was left untouched and time. It’s the old magic of compound interest at work. Log onto an online compound interest calculator, punch in 1 million of any currency and over 70 years at an annual interest of 5.1 per cent that compounds monthly you reach over 35 million.

But let’s make this a bit more ‘real’. How can you use this magic to create your first million — in, say, half the time?

First off, this is a very realistic goal. Our working lifespans a few decades, so stashing money away for 35 years is a reasonable scenario. It would take you to your mid 50s if you started at 20.

Next, let’s look at what it takes to create your first million, relying on compound interest to do the hard work for you.

It takes one of two approaches: you can either start with a lump sum, and leave it alone for 35 years — à la the Hyderabad situation — or start with a smaller sum, keep adding to it and leave the whole amount alone for 35 years.

Scenario one: assuming an annual interest of 5 per cent and compounding returns, put $195,000 into your account on day one. Leave it alone and 35 years on you have over a $1m.

Scenario two: start with $10,000 and add $10,000 each year for 35 years. Assume an annual interest rate of 5 per cent and you will be a millionaire at the end.

If you’re fortunate enough to have a higher interest rate available, it means getting to your million in less time, or having more in 35 years. Let’s look at what a 2 per cent increase in interest does in these two instances.

For scenario one, a 2 per cent increase in interest takes your end amount to over $2m.

For scenario two, with $10,000 deposited and $10,000 added annually at 7 per cent interest, you end up with just over $1.5m.

There are two things to note here. First, just look at the difference a 2 per cent increase in interest does. Secondly, and perhaps more significantly, look at the difference of being able to compound more to start with. The larger sum of $195,000 means all of that money earns interest from day one, and all of it is compounded throughout the 35 years. That’s why you get a $500,000 extra compared to the topped-up version. That’s a huge difference.

Did I do this when I was 20? No. Did I even know about any of this when I was 20? No. But I do now, and so do you. If you didn’t do it back then, the next best time to start is right now. So get to it, as you never know when you’ll need that extra money.

Mr Ali Khan, the man who sent the $1.22m to a UK bank account during those turbulent times 70 years ago is said to have been one of the wealthiest people of all time. In 1937, he was featured on the cover of Time magazine, labelled as the fifth richest man in history and the richest Indian ever.

Fast forward to his grandson and successor, 85-year-old Mukarram Jah. To my knowledge, he currently lives in an apartment in Turkey with his fifth wife. It’s reported he lost much of his wealth in divorce settlements, and I’m sure he’d appreciate a boost to his bottom line.

The jury is still out as to who exactly will get the $42.74m and how much of it; 120 descendants are allegedly preparing to challenge any ruling that denies them their share with claims from both India and Pakistan.

I wonder what Mr Ali Khan would have made of it all, He was quite the character from what I read, using his 185 carat Jacob diamond as a paperweight, knitting his socks, and writing poetry. The $1.22m was small change for him when he made that transfer but the family’s fortunes have changed over the decades. Nothing is for ever.

Nima Abu Wardeh is a broadcast journalist, columnist and blogger. Share her journey on finding-nima.com

Updated: October 10, 2019 04:29 PM

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