Updated: Nov 21, 2020
There are lots of principles of finance that are driven by compound interest. Albert Einstein called compound interest the most powerful force in the universe. The only downside to compound interest is that it takes time. The biggest gains you'll receive will always come in your last year of compounding, so it's important to let your money compound for as long as possible.
It's so strong that if each person were given $8,000 at birth, by their mid-50s they would all have at least $1 million. It's that powerful, but again, it takes time. So the sooner you start compounding the better, and the longer you can let it compound the better.
Interesting Fact: A person saving $50,000 by 25 and investing that money until their 65th birthday would result in greater wealth than a person saving $500,000 at 55 and investing until their 65th birthday assuming an average growth rate of 10%.
Another downside to compound interest is that it needs a decent chunk of money to start with in order to see substantial gains. Either a good sized starting amount (that's called a Principal) or a lot of time to compound. For instance, if George Washington saved $1 in 1776 and let it compound to 2020, it'd be worth billions, but if he had invested $1,000 it'd be worth trillions. (Note: I used 10% as the compounding interest rate)
If someone had put $10,000 into the S&P 500 in 1950 and let it compound until 2000, they would have made about $9 million. The S&P 500 had an average growth rate of about 9.5% during this time.
For someone in their 20s, it's important to save as much as possible. Saving $5,000 per year between the ages of 21-30 is the difference between having $100,000 and $1 million in the bank by the age of 65.
Then by a person's mid-50s, they can stop contributing to their retirement account because the amount gained from interest will be greater than the amount they can afford to contribute. So when that happens, feel free to spend your income like a lottery winner with a drinking problem. Don't touch the amount in your retirement account until it's time to retire, but the income from your day job will be entirely disposable, and that's when you should buy your designer clothes and take expensive vacations.
There's a time and place to be flashy, and unless you have enough money to never work again, it's not the time.