Personal Finance Friday - The Wonders of Compounding

Compound interest is “the eighth wonder of the world”.
“He who understands it, earns it; he who doesn’t, pays it,” 

Albert Einstein

I guess I should start with a basic definition of what compounding means. It’s the idea of something growing at a faster and faster rate. For example, you have two people who get married and have 2 kids together.  There are now 4 people. Their two kids get married and have two kids each, now there are 10 people. Then 22, then 46, and so on. Families are an example of exponential growth or compound growth. Where we usually talk about this concept is interest rates or investment returns. If you have $1000 and you are going to get a 10% return per year, at the end of that year you have $1100. By the end of the next year its $1210, a $110 increase up from the $100 because of compound growth. It’s easy to wrap your head around that but if you move 10 years down the road, that number is now $2590 and your earnings are $230 for that year.  If we jump even further into the future, say 20 years, your $1,000 is now $6,720 and another 10 years and it’s $17,450, and another ten years and it’s $45,259...so in 40 years your original $1,000 has grown to $45,000... 40 years seems intangible or super long but it’s about the length of an average career path. You will have that time or more to be saving and investing in your life.

It is know that the human mind does not do well with exponential or compound growth. We are much better with linear things, things that just change by the same amount each time. Understanding how powerful compound is can really change your behavior.

Think about that $1000... You could have some fun with that $1000 right now. But is it worth the almost $50,000 you will lose out on in the future?! Some people might say, "Hey you don't know if you are going to be around in 40 years? enjoy it now!".... I say don’t be a loser!...They say Carpe Diem!... And I say Carpe Diem doesn't feed and take care of you when you are old :). But being a little more serious, when you spend that $1000, you are literally taking $50,000 from your future self. Think about that. Future you looking back at your decision right now and just cursing at your younger self. :) It might sound something like this: "YOU JERK! MAKE THE RIGHT CHOICE SO I CAN HAVE A BETTER LIFE!"

Compounding is amazing, USE that incredible tool to your advantage. Yes it is hard, that's why it’s amazing and most people don't take advantage of it. Don't be like most people!