Compound Interest
The concept of interest is somewhat basic; committing a sum of money to an investment for a period of time yields an additional amount of money as a reward for use of that money. Banks and other financial institutions reward patrons with interest; credit card and mortgage charge interest for lending people money.
Imagine you owe $10K on a credit card which charges 18% interest. Since the 18% number is a yearly number, you can think of the interest rate as a monthly rate of 18% divided by 12, or 1.5% per month. With no payment by the end of the billing cycle, a month interest charge of $150 (1.5% of $10K) will accrue. Now your balance is $10150. Go another month without paying? The second month you'll see a charge of 1.5% of $10150, or $152.25, giving you a balance of $10302.25. The third month? The charge is $154.53.
That finance charge creeps up more and more each month: $150, $152.25, $154.53. As it creeps up higher, your outstanding credit card balance grows at an ever increasing rate. That's really bad news since you're the debtor.
But it's great news if you're the lender. Let's turn the tables - instead of borrowing from the credit card company, lets make you the lender. Every month, you'd be making more money than you did the month before. The first month your monthly income is $150 (the same the credit card company charged you). After a year - $179.34. After five years - $366.48! This is the magic of compounding interest. All those monthly payments add up; at the end of 60 months (five years), you'd have amassed $24,798 - nearly a $15K return on your original $10K.
While it's unlikely you'll find an investment that returns 18% - unless you start issuing credit cards - it's perfectly reasonable to assume an inflation-adjusted 6% return over time in the equities market, which would still net you over $3,500 over the same five years. First $50, after a year $53, after five - $67. The lower interest rate compounds more slowly, but after five years the monthly income is $17 (or 34%) more than it was at the start. The longer you reinvest that interest, the more and faster it grows. That's the magic of compound interest.
Rule of 72
A handy estimating tool figuring out the time it takes for an investment to double. The formula states the following: to double your money, simply match a interest rate and holding period that multiply together to yield 72. To see some examples, click below...
Reversion to the Mean
Reversion to the mean is just a way of saying "Over time, things average out". Take a coin flip. Do it once, you'll get either a 100% head or a 100% tail. Flip 100 times, it's quite unlikely you'll see 100 heads or 100 tails. As you flip more and more, the result will "revert" to the mean (or expected average), which for a coin flip is 50/50. Investment behave in similar ways; the longer you hold the investment, the more flips of the coin happen and the nearer you will approach the expected return.