You’ve got assets on one side and liabilities on the other. But the story doesn’t end at the snapshot. Over time, some assets grow and some shrink. Some liabilities stay manageable and some snowball. The force behind both? Compound interest.
Appreciation: when assets grow
Appreciation is when something increases in value over time.
- A home bought for €200,000 that’s now worth €280,000 has appreciated by €80,000
- An index fund purchased for €5,000 that grows to €12,000 has appreciated
- Even a savings account appreciates (slowly) when it earns interest
Historically, broad stock market investments have returned around 4-6% per year after inflation across major developed markets, with US historical data sitting at the higher end of this range and most non-US developed markets sitting closer to 4-5% (Dimson, Marsh and Staunton’s long-run dataset). Residential property prices have tended to rise a little faster than inflation over long periods in many markets, with very large differences by country and city. These aren’t guarantees and individual countries have had decade-plus periods well below these averages, but they’re the long-term trend.
The key insight: appreciation rewards patience. The longer you hold an appreciating asset, the more it compounds.
Depreciation: when assets shrink
Depreciation is when something loses value over time.
- A new car loses roughly 15-20% of its value in the first year. After five years, it’s worth about 40% of what you paid (a common estimate in European and US used-car markets; the rate varies by model and country)
- A laptop bought for €1,200 is worth a few hundred within a few years
- Furniture, electronics, clothing: almost everything you buy for personal use depreciates
This isn’t a moral judgment. It’s just how things work. Cars get you from A to B. Laptops help you work. But they are not investments. They’re expenses that happen to be physical objects.
The force behind both: compound interest
Compound interest is the engine that makes appreciation powerful and depreciation devastating. It’s the same mechanism, just working in opposite directions.
Simple interest is straightforward: you earn a set percentage on your original amount every period. Compound interest is different: you earn a percentage on your original amount plus all the interest you’ve already accumulated. Your interest earns interest.
| Metric | Simple Interest | Compound Interest |
|---|---|---|
| Starting amount | €1,000 | €1,000 |
| Rate | 7% | 7% |
| Time | 30 years | 30 years |
| Final value | €3,100 | €7,612 |
Same starting amount. Same rate. A factor of more than two difference. And the gap only widens with time.
Three levers, two directions
Compound interest has three variables:
- The rate. Higher returns mean faster growth. A 7% return compounds much faster than a 2% return
- The amount. More money compounding means more growth. This is why saving matters
- Time. Often the most powerful lever over long horizons. The longer your money compounds, the more dramatic the effect
When these levers work for you, when you’re saving and investing, the result is wealth building. When they work against you, when you’re carrying high-interest debt, the result is a debt spiral.
Compound interest on debt: the dark side
The same force that grows your savings also grows your debt. When you carry a credit card balance at 22%, the interest is added to what you owe. Next month, you’re paying interest on the interest. The debt snowballs.
€3,000 at 22% with minimum payments can cost you over €6,000 in total. You paid for the original purchases twice: once at the register, and once to the bank.
This is why high-interest debt is so dangerous. It’s compound interest working against you with a vengeance.
Why starting early matters so much
Two savers. Both invest €200 per month at a 7% average return.
Person A starts at age 25 and stops at 35. Total invested: €24,000. Person B starts at age 35 and keeps going until 65. Total invested: €72,000.
At age 65, Person A has roughly €263,000. Person B has roughly €244,000.
Person A invested one-third as much money and ended up with more. At a steady 7%, ten extra years of compounding beat thirty years of triple contributions; with lower or bumpier returns the gap narrows, but time is still the lever you can’t get back.
Appreciating vs. depreciating assets: a practical guide
When you’re evaluating any purchase or investment, ask: will this be worth more or less in five years?
| Likely to appreciate | Likely to depreciate |
|---|---|
| Broad stock market index funds | New cars |
| Real estate (in growing areas) | Electronics |
| Retirement accounts | Furniture |
| Education (if it increases earning power) | Clothing |
None of this means depreciating things are bad buys. Most people need a car to get to work, or a laptop. The point is to be honest about what they are: expenses, not investments, and to know whether anything on the appreciating side is making up the difference.
What this means in practice
- Where compounding works for people. Broad index funds, retirement accounts and, for some, real estate are the most common ways people let compounding work over long periods, each with its own risks, costs and tax rules depending on your country.
- How depreciation shows up. A used car loses value more slowly than a new one, and financing a depreciating item at a high rate stacks interest on top of the falling value. Whether that trade-off is worth it depends on reliability, warranty and your budget.
- Why high-interest debt matters here. As we covered in the liabilities post, clearing high-interest debt is a guaranteed return equal to its rate, which is hard for any investment to match.
- Why timing matters. Time is often the most powerful lever in compounding, and it’s the one you can’t get back, which is why the start date matters so much in the examples above.
Understanding appreciation and depreciation; and the compound interest that drives both; changes how you see every financial decision. In the next post, we’ll look at another dimension of asset quality: liquidity, and why being unable to access your money when you need it can be just as dangerous as not having any.