This morning I must have been in a very thoughtful mood when I found the two pennies on the ground during my morning jog. Because the thought process that ensued was pretty phenomenal. Read on to hear me elaborate.
First of all, recently I have been doing a lot of reading on the topic of money, wealth, money management, and all that good stuff. In fact, I have read nine money-related books this year so far, and am in the middle of my tenth. Plus, I regularly read money-related blogs… mostly of the early retirement kind (In fact, one such blog inspired me initially to start this blog!) I’m certainly not an expert on the subject, but I am becoming gradually more financially informed.
So anyway, one concept that is basic to the topic of investing is the idea of compounding interest. Investopedia defines compounding interest as follows:
Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan.
Put another way, compounding interest is the interest you get for each period of time (say, a year), but it keeps getting bigger because of the effect of ALL the previous interest. Because of compounding interest, money invested over time can become huge. Take this example: Suppose you put $1000 into some investment (this is a simplistic theoretical example just to make a point). After a year, it grows by 10%. That’s an additional $100. Now its value is $1100. Now suppose that the following year, it also grows by another 10%. This time it’s an additional $110 (!). Now its value is $1210. The following year it grows by another 10%. That’s an additional $121! Now its value is $1331 (Daaaang, that’s already some nice appreciation). It turns out, at the theoretical rate of growth of 10% per year, this $1000 will double in 8 years… yielding $2143.59.
Not bad huh?
Well, anyway, back to me and my blog. Today I was on a run, which I do frequently (as discussed here), when I took a little rest at a Sacramento city park. I looked down on the concrete below the picnic table where I sat and saw… MOOLA! Well, okay, it was two pennies. But I have learned never to laugh at “small amounts” (as the saying goes, “Take care of the pennies and the dollars will take care of themselves.” I have been practicing the little penny-on-the-ground trick since 2006). Anyway, so I pocketed my financial find, but first, I made a little calculation, since I was pondering this thing called compounding interest.
I asked myself, “If these two pennies represented a fund that doubled every year, how much would it be worth after 20 years?” I got out my calculator on my phone. The answer I saw was pretty astonishing.
Get ready.
After twenty years, with these two pennies doubling every year, the fund would be worth a whopping twenty thousand, nine-hundred, seventy-one dollars and fifty cents ($20,971.52). That’s a new car!
It doesn’t stop there though. After this, I wondered what would happy if you kept up this multiplication process for another ten years, so for a total of thirty years. I found out the fund would be worth…
TWENTY ONE MILLION, FOUR-HUNDRED AND SEVENTY FOUR THOUSAND, EIGHT-HUNDRED AND THIRTY SIX DOLLARS AND FORTY-EIGHT CENTS (21,474,836.48)!
I’m not frigging kidding! Starting from just two cents, if you were to double its value thirty times, you get almost $21.5 million dollars!
For those who are crazy numbers guys like me, I’ll lay out all the details:
| Year 0 Balance: $0.02 | Year 16 Balance: $1310.72 |
| Year 1 Balance: $0.04 | Year 17 Balance: $2621.44 |
| Year 2 Balance: $0.08 | Year 18 Balance: $5242.88 |
| Year 3 Balance: $0.16 | Year 19 Balance: $10485.76 |
| Year 4 Balance: $0.32 | Year 20 Balance: $20,971.52 |
| Year 5 Balance: $0.64 | Year 21 Balance: $41,943.04 |
| Year 6 Balance: $1.28 | Year 22 Balance: $83,886.08 |
| Year 7 Balance: $2.56 | Year 23 Balance: $167,772.16 |
| Year 8 Balance: $5.12 | Year 24 Balance: $335,544.32 |
| Year 9 Balance: $10.24 | Year 25 Balance: $671,088.64 |
| Year 10 Balance: $20.48 | Year 26 Balance: $1,342,177.28 |
| Year 11 Balance: $40.96 | Year 27 Balance: $2,684,354.56 |
| Year 12 Balance: $81.92 | Year 28 Balance: $5,368,709.12 |
| Year 13 Balance: $163.84 | Year 29 Balance: $10,737,418.24 |
| Year 14 Balance: $327.68 | Year 30 Balance: $21,474,836.48 |
| Year 15 Balance: $655.36 |
Notice some strange and amazing things:
- It takes an entire six years to get the fund to surpass $1. That’s six years of sitting there thinking you’re not getting anything much out of it.
- It takes another ten years before it even surpasses $1000. And while that is pretty frigging amazing, that’s after waiting sixteen years!
- Even after twenty years, the $20k+ amount, while very impressive, just really doesn’t give you a CLUE of what’s about to come.
- By year twenty three, the fund blows past $100k, and then things just explode…
- It takes an entire 26 years for the fund to get to $1 million… after that, it takes ONE year to get to $2 million (actually $2.6 million). Think about it. 26 years to get to the first million, but only one year later it’s almost to $3 million! Holy guacamole!
- Within five years of getting to the first million, the fund ballons to nearly $21.5 million.
Are you following where I’m going with this? This hypothetical scenario shows very clearly the power of compounding interest. I sat there with the two pennies in my hand as I marveled at this. What starts out as small gains keeps getting bigger… and bigger… and bigger… until it’s basically like some strange fantasy novel, and the number rises at an absurd rate.
To someone privy to the principal of compound interest, this situation would have gotten very exciting back in year 1, when the two cents became four. Because that person would know what was to come. But to someone who doesn’t get it, this could be very frustrating… because who really cares about adding another two cents?
Isn’t it possible we do this in our own lives sometimes, without even realizing it? That’s really the point I’m trying to make here. Not just about money. It’s about life. It seems to me that so many people underestimate the compounding effect, not only of their money, but of their energy, their time, their efforts. While some people go out and do amazing things, because they get that over time their efforts will create more and more amazing results, compounding just like the pennies in the example above, other people don’t even fricking bother to try because they don’t see what could happen if they did. And so they miss out on all the compounding effects of their efforts.
For myself, I have done it both ways. I distinctly remember back when I was a kid, and I had a vision of myself doing piano concerts before an adoring crowd. Back when I sucked at the piano. But I put in the time, and I got good at the piano… and have played many shows before adoring crowds.
Meanwhile, back at the end of college, when I had visions of becoming a rapper (which incidentally started my song-writing career and in some ways my composition career as a well), I held onto that vision and inched my way to where I am now, having written dozens and dozens of songs and compositions.
Even my teaching studio started with one student. And then another. And then another. And now I have something cool that gives benefit every single week.
On the flip side, I’ve also been guilty of blowing my opportunity, and of quitting (at least temporarily) at things that are important to me and therefore missing out on the added value of momentum from STAYING with it (Er, um… can you say, recording, marketing, and selling my songs??). Again, it’s like the pennies example. Imagine going ten years into the process mentioned above, where your fund has reached the staggering number of $20.48… and then deciding (heaven forbid) to quit. After all, it’s only $20, right? Let’s say you use it to buy a dinner and milk shake at Mel’s Diner. You know, to celebrate the novelty of raising $20 out of one penny. And then, let’s say you decide to start over again. Back at $0.01. Another ten years go by, and your fund is back at $20.48. In reality, twenty years have gone by. And as I just said before, if you had stayed in the game, your fund would be worth $20,971.52…. that’s 1000 times more valuable then your fund would be if you quit after ten years to start over again.
And so it is with life. The things that are valuable to us that we stick at, we grow in power and ability. And our powers multiply, even compound. But the things we have the misfortune of quitting or stopping, we potentially lose all that missed potential.
I know this might sound pretty heavy-handed, so bear with me. For now I’ll just say that the numbers I’ve discussed tell a very revealing story that can be applied not only to money, but to everything in life.
Basically, the morale of the story is:
Don’t quit stuff that matters to you! You could be giving up the spiritual, emotional, social, creative, or even financial equivalent of $21 million!!
I’ll say it again:
Don’t quit stuff that matters to you! You could be giving up the spiritual, emotional, social, creative, or even financial equivalent of $21 million!!