If I offered you $1 million dollars now OR a shiny penny that would double the amount every day for 30 days, which would you choose? I bet you would take the million and laugh all the way to the bank for any poor sucker that took the penny. However, you might not be getting the last laugh. Read on to discover how one small penny could become over $5 million in just 30 days.
Albert Einstein supposedly once called compound interest “the greatest mathematical discovery of all time”. Compound interest is a simple idea with powerful effects. At its core, compounding is the process of earning returns on previously generated returns. You would invest your money and anything you get back, the returns, you would then reinvest. Let’s look at the penny. On day 1 we start and end with $0.01, not exciting. On day 2 we start with $0.01, but the amount doubles, so we end with $0.02. This continues for thirty days. How much do we end with on day 30? Take a look at the following table:
That’s right, one penny turned into $5,368,709.12 in thirty days! Now, you may be getting ready to call this bogus, or something worse, and stop reading. I’ll level with you. It is highly unlikely that any of us will achieve a 100% return every day. However, this example should serve to highlight the power of compounding. By allowing your money to make money puts you in a powerful position to increase your net worth. Now, you may be wondering, “this all sounds good, but how can I start benefiting from compound interest?”. Check out the following three helpful tips.
In our younger years we have one of the greatest assets that money cannot buy: Time! The sooner you start investing, the longer your money can compound and grow. Let’s look at an example. Mike invested $10,000 when he was 25 at an annual interest rate of 5%. By the time Mike is 50, this amount will become $33,863.55. Jim wasn’t as smart as Mike, so he delayed his investment until he was 30. Assuming Jim made the same $10,000 investment as Mike, he would have $26,532.98 at age 50. That is a difference of $7,330.57 by delaying an investment 5 years! Moral of the story, start investing young and give your money more time to grow.
It might not be possible to invest a large lump sum like Mike and Jim did in our previous example. That’s fine. Determine what is a reasonable amount for you to invest each month, even $20 is good. Next, commit to investing this amount each month. Find investment accounts that provide tax advantages. I personally invest in a Roth IRA due to the tax benefits I receive. With a Roth IRA, I pay taxes when I contribute today. Assuming I don’t make any early withdrawals, I will be able to take out my money tax free after age 59 1/2.
It might feel like it’s just $20 and not that much, so why bother. Compounding takes time. Just like it takes time to lose weight or build muscle, it takes time for compounding to work its magic. This leads to my final piece of advice…
Patience Young Grasshopper
Compounding takes time. Look back at our penny table. What if you started with a penny and on day 10 I offered you the $1 million again? If you looked at what you had on day 10, $5.12, you might be tempted to take the $1 million. However, you would have left nearly $4.4 million on the table! Give your money time to grow. It will, but it just needs time.
Hopefully you have enjoyed this quick discussion on compound interest. It is truly amazing the power that compounding holds! If, in the future, you are ever offered a penny that doubles the amount every day or $1 million, you know which to choose. Also, remember where you got the advice 😉
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