I recently saw a very interesting video that asked a number of regular people if they would rather have a million dollars now or take a penny now and double the amount every day for the next 30 days. As expected, 90% of people chose the million dollars now option. I would have made this choice myself a few years ago. But this would have been the poorer choice, because you would have short changed yourself by over $4 million at the end of the 30 day period. Don’t believe me? Look at penny table calculation on the right. The simple act of doubling your previous day’s investment can rapidly reap huge rewards thanks to the powerful concept known as compounding.

Now a 100% return every day is highly unlikely, but the principle of compounding holds true for even smaller returns (though it will take longer than a month to make your fortune). This is why compounding is a core aspect of good personal finance and the reason why the rich get richer. As outlined in Kiplinger, when you’re young, you have an asset money can’t buy: TIME. Start saving now and turn pocket change into riches. Compound interest has been called the eighth wonder of the world. And with good reason. It magically turns a little bit of money, invested wisely, into a whole lot of cash. Even Albert Einstein is said to have called it one of the greatest mathematical concepts of our time.

But you don’t need to be a genius to harness the power of compound interest. Even the most average of Joes can use it to make money, without having to know the theory of relativity.

Here’s the gist which you can clearly see in the penny table: When you save or invest, your money earns interest, or appreciates. The next year, you earn interest on your original money and the interest from the first year. In the third year, you earn interest on your original money and the interest from the first two years. And so on. It’s like a snowball effect – roll it down a snowy hill and it’ll build on itself to get bigger and bigger before you know it.

To make compounding work for you follow these three basic principles:

**1. The sooner you start, the better.** Compounding is a function of the return you get and time. For most people a 3 to 7 percent is realistic, but time is a diminishing commodity. So the younger you are, the more time you have to really make compounding work for you, and the wealthier you can become. The next best thing to starting early is starting now. Consider this example: Amy, a 22-year-old university graduate, saves $300 per month into an account earning 10% per year for 6 years. Then at age 28, she starts a family and decides to stay home with the

children full time. By then, Amy had kicked in $21,600 of her own money. But even if she doesn’t contribute another cent ever, her money would grow to a million bucks by the time she turned 65!

**2. Make regular investments. **Especially via a tax advantaged 401K or IRA plan or in a good high yield savings account for your post-tax savings. Remain disciplined, and make saving a priority. The more you save, the more you can let compounding work its magic. Even a little bit goes a long way, and you can start with as little as $20 a month.

**3. Be patient. **Compounding only works if you allow your investment (capital) to grow. It takes time to see the wonders of compounding returns, and as you can see in the penny table the most growth comes at the very end. Compounding creates a snowball of money and you will get rich if you start young, invest wisely and leave your money alone over the long term.

Related:

~ 5 Steps to Take Now in Preparation for Double Digit Inflation

~ 10 ways to Quickly Improve Cash Flow by Creating Passive Investment Income

~ The “Must Have” Second Career For Everyone

{ 16 comments… read them below or add one }

I think , if the teacher was a teacher, then she would have allowed the whole class to sit in a circle, to discuss everyone’s opinion as to what is the most practical approach to this story about doubling penny.

To have insulted you in front of the class, just shows her weakness and if I was principal of the school, then I would have reprimanded her for doing so. If she disagreed, then I would have fired her!

Keep me posted!

kj

What I want to know is where someone would get 10,000 pennies?

Sorry Andy, but that’s not correct. The answer is $10,737,418. You double the penny the following day, (which would be day one). So you would have 2 pennies on day one; 4 on day two; 8 on day three; 16 on day four…so on and so forth… (2^30).

Makes it hard to trust a guy on financial advice when they can’t do math….

My assumption is that on day one you get the one penny, and it doubles from day 2. The math works either way…with the point being to illustrate the power of compounding.

You are an ass

Don-key

ur mean

He says take a penny now and double it every day for 30 days. Day 2 is a day away from day 1. He is correct….it’s not his math…it’s your reading.

What u say is true in a way but my dad is a financial advisor and he has told me a lot more and I honestly don’t really agree with u.

Hi Sophie,

What advice could you give that is better than the above example?

Thanks,

Alison

…and this Orland, is why you will never have any money

The answer here is wrong, you wont get 5 million dollars, you will get over 10 million

2 to power of 30 is

1,073,741,824

divided by 100 (a dollar)

10,737,418.24

The mistake he made is he is only counting the last payment of 5 million and change, he is forgetting about the other 29 payments that were made to you. So you aren’t getting 4 million dollars more than the one time million dollar payment, you are getting almost 10 million more than the million dollar payment.

In my youth I would have been tempted to go for the “million dollars” option. But, back then I didn’t understand compound interest. Compound interest can be effective, but it does depend on so many variables, e.g. the rate of inflation, interest rates, the amount saved and over how long. Unfortunately the answer is never black and white.

It’s amazing! It is a great illusion, assuming you understand the full meaning of the word illusion. First of all, that table that you have shown has nothing to do with compound interest, or by extension, the power of compounding! The power of compounding, on the other hand, is the greatest of all the illusions ever invented by human kind. I can see that your intentions are good. And the idea of encouraging people to save for a better future are indeed honorable! But, why use examples that are sub real? Why bring names of people like Albert Einstein into the equation? I also read somewhere that he said “…the power of compounding was said to be deemed the eight wonder of the world…” If that is true, the question then would be: why did he use the verbs in its past tense? Is it because he realized towards the end of his life that the power of compounding was an incredible illusion and not REAL? An illusion when it is used to your advantage, but REAL when it is used against you? What is then that the power of compounding really is? It is just the perfect formula for the PRESERVATION of POWER by the elite! It ain’t gonna help any poor guy! If in 1950 you had put aside a $1 000 000.00 compounded at about 3% annually, after effects of inflation you would have now arround $1 800 000.00 Not even 2 million dollars! Of course, you would still be a millionaire today…but then again, you were already a millionaire back then! So, where is the holly grail here? What about the averages Joes, as you said, those Joes that don’t need to know the theory of relativity…let see. If a nurse was able to make about $200.00 a month, or a teacher was able to make arround $400.00 montly, and a factory worker could make $160.00 a month, for these people the idea of putting money aside was way beyond their means. The same applies today, my friend. However, let’s pretend that these people knew the power of compounding and were able to put aside $1000.00 compounded at 3%, just as the millionaire did. How much money would they have today after the effects of inflation? They would have about $1 800.00 to $2 000.00! Big deal!!! So…what would be their status today? THE SAME! Who doesn’t have $2 000.00 now? Furtheremore, how many years were these people invested? A LIFE TIME OF 60 YEARS! Finally, let me conclude with this: If you were rich yesterday, the power of compounding will keep you rich today, and if you were poor yesterday, the power of compounding has the potential to keep you poorer today. Could you please, I beg you, show to me in your reply how wrong am I? Assuming you will reply. And as I said at the beginning, it is AMAZING isn’t it?

Freak!!!

You are so right.In my business class last night, my professor brought this up. She really bought into this idea, but in reality, she is an idiot. She tried to say that she did the math and you can become a millionaire in 1.5 years, no matter what your salary is. Well, theoretically, the table is saying you can become a millionaire in less than a month, so I don’t know what math she did. And the table is rhetorical, its not real. She told me that I just didn’t want it enough. She insulted me in front of the class for not having “drive”. The reality is, trying to save money like this is irresponsible because it is impossible to budget. I know that we live in a hidden caste system, so I will never be a millionaire, that is not something that I strive for. I do strive to set a budget for myself that is realistic, so that I can pay my mortgage, keep food on the table, pay for car repairs, go on the occasional vacation, you know, life things.