Compound Interest: The 8th wonder of the world
Albert Einstein, widely acknowledged as one of the greatest physicists of all time, is known for solving the mass-energy equivalence formula: E= mc², which arises from his theory of relativity.
But Einstein also less famously worked out another important piece of mathematics which is the not-so-secret ingredient to building wealth: compound interest.
The benefits of compound interest in wealth building are well documented, by all the world’s most famous investors, no less. You can find many articles here which go in-depth on why you need to make compounding a key part of your life.
So why write another one, I hear you ask? Well, I have one example of compound interest I’d like to share with you, which no matter how many times I see it written or hear about it, literally blows my mind. If you ever needed to convince someone of the power of compounding, I suggest you use this example.
The $0.01 Coin
If you live in the US or have ever visited, you will be familiar with the humble penny. You probably want this little beauty to be taken out of circulation?
But imagine you are in the US, and you realize that this small coin in your hand is special. This particular penny doubles every time you flip it, but you can’t flip it more than once a day. How many times do you think it would take to get to $5.4 million? 3 months? 6 months? A year?
You wouldn’t even see out most months of the year! After 30 days, your tiny little penny would have grown to $5.4 million! If you continued, trying to get to the end of the second month, by day 56 you would be at 360 Trillion!
Considering total world GDP is around 80 Trillion, that is absolutely bonkers.
Now, it’s extremely difficult to achieve a compounding rate of 100% per day, but if you are able to do it, this example shows the power of compounding in all its glory. Heck, even if you are able to do 100% per year, you’re going to be out of this world rich.
The Beauty Of Small Wins
Luckily for us mere mortals, you don’t have to get out of this world returns to make compounding work for you. The very best rarely do better than 30% per year returns on average. Those who do, are billionaire-level wealthy. Most of us don’t aspire to be billionaires, nor do we need to be. What we do want, is our money to work for us, so that we can live well and enjoy the fruits of our labor.
Warren Buffet & Charlie Munger have long advocated for investors to buy a basket of stocks like the S&P 500, sit on it, and enjoy the benefits of compounding. A quick look at the last 50 years and it’s not hard to see why, with the index producing an average annualized return of 10.9%. Now that might sound underwhelming compared to some of the numbers discussed earlier, but combined with an investor's second-best friend, time, you see the true power come to life.
$10,000 invested in 1957 at index inception, would be worth $10,374,363.41 today. This illustrates the power and gives another clear example of why you should let compounding do the heavy lifting in your investing journey, just like the very best do.
The math required to get rich is simple. You don’t need to be Einstein to solve this equation, do you?