The power of compounding

Over the years, we’ve been asked by clients to help their kids or grandkids establish good financial habits and understand important financial principles.  One such principle essential for financial success is understanding the power of compound interest.  We know we’re preaching to the choir.

There’s a reason that Charlie Munger said, “The first rule of compounding is to never interrupt it unnecessarily.”  Here’s why.  Let’s say an investor starts with a penny and by some magical ability, they can double its value every day for a month straight.  How much do you suppose that penny would be worth at the end of 31 days?  Here’s what the first 10 days look like.

Day Amount
1 $0.01
2 $0.02
3 $0.04
4 $0.08
5 $0.16
6 $0.32
7 $0.64
8 $1.28
9 $2.56
10 $5.12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Knowing what you know so far, would you rather have $1 million or continue doubling this penny’s value for another three weeks?

Let’s continue…

11 $10.24
12 $20.48
13 $41
14 $82
15 $164
16 $327
17 $655
18 $1,310
19 $2,621
20 $5,242
21 $10,485
22 $20,971
23 $41,943
24 $83,886
25 $167,772
26 $335,544
27 $671,088
28 $1,342,177
29 $2,684,354
30 $5,368,709
31 $10,737,418

You read that right.  A penny that doubles in value every day turns into $10.7 million after 31 days.

When viewed graphically, the power of compounding takes on the shape of a hockey stick.

Now, in real life it takes longer than a day to double your money, but what’s fascinating about this “compound-interest-on-steroids” example is how it goes from $5,242 to $10.7 million in only 11 days.  The takeaway is that once you hit a critical mass, the doublings really start to add up quickly.  But getting to that critical mass can take a long time, which means consistency, discipline, and patience are essential to investment and financial success.

The concept of compounding goes beyond finance.  Athletes, performers, and entrepreneurs are often labeled an overnight success, but there is no such thing.  Most of the time the work has been done in the dark, often for years, before an individual gets their big break or bursts onto the scene.  Then suddenly, their success appears out of nowhere.  But Amazon founder Jeff Bezos sums this up well, “All overnight successes take 10 years.”

The growth of Chinese bamboo, the stonecutter’s credo, John Wooden’s UCLA basketball teams, Jim Collins’ flywheel…they’re all examples of compounding.

The fuel needed for compounding is time.  The more time that passes, the more compounding occurs.  Since we started with a Munger quote, let’s finish with a Buffett statistic.  Over 90% of Warren Buffett’s net worth has occurred since his 65th birthday.  This shows why compounding is a bedrock principle of success, financial or otherwise.

 

 

Clicking on the links above may result in you leaving the Pittenger & Anderson, Inc. website. The opinions and ideas expressed on these external websites are those of third-party vendors and Pittenger & Anderson, Inc. has not approved or endorsed any of this third-party content. For the full Terms & Conditions of using the Pittenger & Anderson, Inc. website, click on this link.

 

Pittenger & Anderson, Inc. does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.  Additionally, the information presented here is not intended to be a recommendation to buy or sell any specific security.  To learn more about our firm and investment approach, check out our Form ADV.

 

To view this article and others like it online, visit the P&A blog at https://pittand.com/blog/.

Click here to download the PDF version of this article.

Was this post helpful?

Previous

Next

Since 1995, Pittenger & Anderson has guided individuals and families going through money-in-motion events. We are a fee-only Registered Investment Advisor and a full-time fiduciary providing investment management, financial planning, and complimentary services to 800+ clients in over 30 U.S. states.

Get P&A in your inbox!

Get P&A in your inbox!

Our once-a-month email is designed to cover topics that impact your financial life, whether you’re just starting out, mid-career, or enjoying retirement.  Learn about planning opportunities, our thoughts on the markets, and many other empowering topics.  We will never sell or give away your email address, nor will we spam you.  We embrace the Golden Rule.

You have Successfully Subscribed!

The Confidence Your Money is Looking For

The Confidence Your Money is Looking For

Please enter your name and email below.

You have Successfully Subscribed!