The Power of Compounding – $1 Million Now or Penny Doubling for a Month

16 comments

MSN had 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 for 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 ycompund interestou would have short changed yourself by over $4 Million at month-end. 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 a 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 – 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

Bookmark and Share

Liked what you read? Then stay connected and get the latest articles via RSS, Email or Facebook

{ 4 comments… read them below or add one }

Arthur Kerouac April 2, 2013 at 2:54 pm

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

Reply

christo930 May 31, 2012 at 5:29 pm

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.

Reply

Jamie Anderson December 14, 2010 at 12:57 pm

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.

Reply

orland October 17, 2010 at 12:53 am

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?

Reply

Leave a Comment


6 × 9 =

{ 12 trackbacks }

Previous post:

Next post:

Disclaimer: The information contained on Saving to Invest (this site) is for general information purposes only and does not constitute factual or professional financial advice. In accordance with FTC guidelines, we disclose that we may have a financial relationship with some of the merchants/companies mentioned on this website. We do our best to maintain current information, but due to the rapidly changing environment, some information may have changed since it was published. Please do the appropriate research before participating in any third party offers. Refer to the Privacy Policy and Terms of Use for more information