Money gets you that control. It puts you in the driver’s seat. It gives you that ability to dictate how you want to spend your time, with whom you want to spend that time and for how long. Not only does it buy you options, it also buys you freedom.

And that path to freedom starts with savings first. You have to set money aside, whatever the amount, to get to a point that first takes care of emergencies. Like a car breaking down, an unexpected medical expense or in the worst-case situation, a job loss.

So a healthy savings pile is crucial to tide us through such emergencies. And the data shows that we as Americans are failing miserably at this first step towards stability. 

Now some of that is not our own doing. Circumstances prevent us from taking this first step because incomes have not kept up with the rise in the cost of living. And that is so unfortunate.

But with that aside, some of it is behavioral as well. Consumerism runs rampant in our society and Americans are the best at that. I mean worst at that. We are expected to spend because our global economy relies upon the fact that when no one consumes, Americans will pick up the slack.

That is sad and we need to reverse that because not only does it wreak havoc with our personal finances, it also destroys our world. Literally.

So we need to not heed that proclamation to spend but instead, save. I say start with setting aside at a minimum six months of living expenses in something that is highly liquid and accessible. Like a bank. And when an expense emergency strikes, you are ready with ammunition to blunt the impact.

Now liquidity and accessibility has a cost and that cost comes in the form of lower returns. Or interest rates to be more precise. You don’t earn as much on your money because it is designed to not earn as much. As of this writing, we are looking at less than one percent interest rates on bank savings accounts. And that is where this money should reside.

So that’s for the shorter-term goals. But we know we can’t keep stashing our cash in the bank for longer-range goals like say saving for retirement. We need rates of returns that are higher, much, much higher than what a bank account yields. 

And the only way that is possible is through the process of investing. And investing means risks but the longer one can remain invested, the lower the risks become. One of the easiest ways to invest and participate in our global economy is through the stock markets. Plural because there is not one stock market. There are many. And we need to participate in all of them.

Stocks as we know are ownership stakes in businesses and they have historically delivered a higher rate of return than what a bank account yields. They have to by design. In the long run of course.

But words are just words. Let’s look at the numbers to see why invest rather than just stash our savings in a bank account. We’ll start first with a single one thousand dollar set aside in these two different vehicles and compare the outcome.

Seven percent for stocks is just about right in the current interest rate environment. It could turn out to be conservative in the long run but as they say, better to be safe than sorry.

So we see the difference.

Now a single one thousand dollars of investment is not going to do much. So instead, say we save a thousand dollars each year. And this is what we get…

So much better. But say the amounts even with that are nowhere close to what you need to buy that freedom.

And you realize that pretty late, say when you turn 60.

So you try to accelerate the savings amount by doing 10x or $10,000 a year for the remaining years. What do we get?

So there is a difference but not as big as you would have expected. And that’s because your contributions did not have as many years to compound.

But what if you realized sooner and could do the same acceleration of saving $10,000 when you turned 40. And you did it for that same 5 years.

A big difference.

And those stock market returns are not going to come easy and this is how bad it could get every now and then.

At least, that’s how bad it has been historically. So expect that but keep on investing.

In parting, a few things:

• Emergency reserves are a must. Six months living expense is the right amount. And this money needs to be liquid and readily accessible.
• And we can’t rely on ‘safe’ investments to meet our long range goals. That money needs to be invested. But that also means small and big declines in the value of your portfolio every now and then. Be ready and willing to endure through those times.
• And Captain Obvious, the sooner we get our savings into investments, the faster we can buy our way to freedom. Not freedom from work but freedom from working on somebody else’s terms.

That’s all I have to say for now.

Thank you for reading.

Cover image credit – Karolina Grabowska, Pexels

And if you can convince the folks at the bank that you have a viable business at hand, the bank will lend you money. And lending means a periodic interest expense that you as a business owner will incur depending upon the terms you signed up for. Plus the money you borrowed to run and grow your business will have to be returned someday.

So your business must earn enough to not only cover all the expenses associated with building and selling your products but also enough to cover the interest expense plus eventually paying the loan off. And then whatever is left over are your profits.

What could you have done instead of borrowing that capital from the bank? You could have convinced the same folks at the bank to give you the money in return for a small piece of your business.

So now the folks who provided you with the much needed capital are partners in your business.

Plus there is no ongoing interest expense because the partners (investors) in your business now are in the same boat as you. And the money doesn’t have to be paid back…in theory. They are now part owners and they want you to succeed because if you succeed, they succeed.

Plus look at it from the bank’s point of view and their risk-reward situation. Their risk if you borrow the money is that your business fails and the bank not only loses the interest income but also the capital they lent.

But if your business turns out to be a startup that becomes the next Apple, they don’t get to participate in all that upside. All they are left with is collecting that measly interest income instead of the gusher of profits that would have flowed to them if they owned a stake in the next Apple. Or Amazon. Or Google.

Because with an equity stake in the business, they own a piece of that business and hence a piece of the profits made by that business.

So owners of businesses inherently make more than lenders because:

• As Naval Ravikant, the founder of AngelList says and I am paraphrasing here – when you are the owner of a business, you own the upside as well as the downside. But when you are a loaner to a business, you do own a guaranteed revenue stream (interest payments) but you also own the downside. So capped upside as a loaner with all the downside.
• Public businesses are run by some of the smartest folks around. We do occasionally hear stories about abuses here and there but in aggregate, these folks are running our businesses the best they could. And no business manager will borrow money at a cost (interest payments) that exceeds profits. So if you own a collection of them, you are bound to out earn a loaner.

The only advantage of being a loaner (lender) is that regardless of what happens to the profits in a business, the lender must get paid their ongoing interest and towards the end of the lending term, the entire loan amount (principal).

So there is a bit of a stability in the value of your investment being a loaner but that’s in the short-term. And that’s assuming the business survives.

As an owner, if business conditions deteriorate, profits decline and the value of that business declines. If that continues for long, the business could permanently shut down and the value of your ownership stake in that business will go to zero.

So stockholders (owners) suffer as well as the bondholders (loaners).

But that is if you own just one business.

The stock market and the bond market allow you to spread your money into hundreds of businesses and not all of these businesses will shutter.

If they did, the stocks will go to zero but so will the bonds. And you’ll have far worse things to worry about than worrying about money if that happens.

So if you are saving money towards goals that are more than a decade out, being an owner must pay out better than being a loaner.

But being an owner (stockholder) over a shorter-term means you are exposed to the full brunt of the volatility in business cycles and volatility as we know cuts both ways.

Thank you for reading.

Cover image credit – Jose Francisco Fernandez Saura, Pexels

And then there are the minimalists and there is a spectrum amongst them. The hard core ones are the planet-first kind who do everything they can to conserve and preserve. Think living off the land and off-grid.

And then there are the pseudo-minimalists who are the mindful consumerists. They do everything within reason to conserve and preserve but prefer not to take it to extremes even if they could afford to.

But wherever you are on that minimalist spectrum, that conservation and preservation mindset by default leads to wealth accumulation.

But ask any 6th-grader who between the two – the uber-consumerist or the minimalist – they think is wealthy and by default, they’d pick the uber-consumerist.

That’s how we are wired. What shows is what counts.

But it’s the minimalist likely swimming in cash while the uber-consumerist is one paycheck away from disaster. That’s the classic rich vs. wealthy debate. People who look rich might not be wealthy and people who appear run-of-the-mill own real wealth.

And you’d think the rich and the wealthy are the same and though there are similarities, there are big differences.

Rich is a state which is more current or transitory. Lottery winners, newly discovered celebrities, star athletes, folks working in high-paying professions such as medicine and law are the rich. They have quite a bit of money flowing in with most of it derived from a single source.

And the rate of outflow sometimes equals or exceeds the rate of inflow. The rich as a state can happen instantly and then it disappears.

Wealth on the other hand is more permanent. It comes through ownership of income-producing assets – enough assets that allows for a life full of choices.

And the income that these assets produce grows with time to a point where it surpasses income needed to support one’s daily existence.

So whether you work or not or if the skills you possess are in demand or not, your standard of living remains unaltered. If the same thing were to happen to a merely rich person, he would quickly become poor.

Wealth buys freedom. Enough wealth that the income it throws surpasses the income you need to live comfortably. Enough wealth that you can stop doing anything remotely resembling work and instead do something that you always wanted to do but couldn’t. You want to work for a non-profit that hardly pays anything, you have the freedom to do that. That business you always had an itch to start, you can do that. Or if all you wanted is to sit back and retire, you can do that too. All of that without impacting your quality of life. That’s critical mass.

And the only path that I know of that is guaranteed to get you there is a slow-boring one because it’s the most tried and true one. There is a reason why we come across many “get rich quick” schemes but never any “get wealthy quick” ones.

Yet behaviorally, the slow-boring path is the hardest to adhere to.

Charles Kinderberger, economic historian and an author of many investment classics, once said that there is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.

And there will always be folks getting richer than you on some of the dumbest things you could have ‘invested’ your money in. Don’t let that take you off the rails away from a well-crafted plan.

And sure, you can strike it rich a million ways but holding on to wealth without a process, without a plan is tough. Because there are a million ways to lose it all.

I am not saying you have to hoard wealth to a point that you forget to live in the now and defer everything to that proverbial future. Because as they say, you can’t go snow-boarding in your nineties.

All I am saying is that there must be a balance between consumption now versus consumption later. That’s consumption smoothing where we tweak and optimize our spending to design a life that has a base level of happiness with occasional spurts of exoticism blended in. Because of course, YOLO.

And forget worrying about what we’ll leave behind for our heirs to inherit. That’s going to be dissipated anyways. I mean we can try but it’s going to be tough because of the human condition and hence the saying ‘shirtsleeves to shirtsleeves in three generations’.

And it makes so much sense. Say you are in the minimalist camp, your kids will absorb all those experiences and maybe implement some or most of them into their own lives. But then that minimalist mindset automatically means wealth accumulation which then gets passed down to your kids. Or at least that’s what most people do.

But then your kids someday have their own kids and now the setup is completely different. Their kids never get to see the struggle. They never experience frugality and choices being made. Life is easy. There is no drive and hence slowly but surely, wealth gets frittered away and the cycle repeats.

So is it any wonder that 70% of wealthy families lose their wealth by the second generation and a stunning 90% by the third¹.

Of course that does not mean you don’t try but many a times, it would be an exercise in futility and it’s good to have that perspective.

So coming back to you, the timeframe to reach critical mass is different for different people. And it’ll come down to two things – your burn rate and your investment returns. Investment returns beyond what’s statistically likely based on the risk-return characteristic of your portfolio are not in your control and neither should you base your financial plan on.

Burn rate is in your control and of course the lower the burn, the sooner you’ll reach critical mass. And one big side benefit of a lower burn rate is that now you are used to living on way less than you could since you’ve designed your life around that. I mean you were able to get to that base level of life satisfaction that your burn buys. And that should be the goal.

So increase the earn, reduce the burn and take the difference and deploy it into a plan that is tailored for you. Do that for some time and critical mass would be within reach far sooner than you realize.

That’s all I have to say. Thank you for reading.

Cover image credit – Joel Santos, Pexels

¹ Chris Taylor. “70% of Rich Families Lose Their Wealth by the Second Generation”, Reuters. June 17, 2015.

Craig L. Israelsen, professor of all things financial planning at the Brigham Young University likens the art of portfolio construction to making salsa. I mean you can add your own flavor to a recipe but ultimately, the ingredients that constitute a wholesome salsa don’t differ much. And so shouldn’t the ingredients of your portfolio.

The recipe is your portfolio’s asset allocation. There are complex elements to it but inherently, not that complex.

Some of the elements that make up a salsa, say salt for example, may not be very exciting. And they are not supposed to be. They are neutralizers.

A well-designed portfolio should have its own set of neutralizers.

But then we’ve got a world where the only thing that matters is how you compare against the S&P 500 index. At least lately. Or God forbid, the Nasdaq. Talking about Nasdaq…

Comparisons against these indices didn’t happen as much during the decade of the 2000s when indices similar to these sucked wind but they happen now because we forget. We are too busy. We take mental shortcuts instead of thinking deeply about what we own and why.

And since when do we compare salsa to 500 ground-up tomatoes? We have created a misconception around what diversification is. The S&P 500 is a diversified set within an asset class. That’s not true diversification. That’s intra-diversification. It’s depth, not breadth.

And Nasdaq’s worse. Yes, yes, a lot of companies that make up that index will go on to change our world but it’s still mostly a narrow subset of the investible universe. And there are other means to own it.

So getting both breadth and depth is true diversification. A multi-asset portfolio that encompasses a need appropriate allocation is what you want.

A 60-year old’s portfolio should look different than that of a 30-year old.

A 60-year old’s portfolio with a solid pension should also look different than that of a 60-year old’s without a pension.

Back to the S&P 500, this is what you get when you own just it.

So the biggest 25 businesses take up almost 45% of your money. Even in a winner take all kind of an economy, that’s too much concentration in just a few businesses if this is all you’ll do with your money.

And large businesses don’t stay large forever. They become stodgy, bureaucratic and unmanageable and eventually get replaced by smaller, more nimble rivals. It is only a rare breed that can maintain their market power for decades on. A prime example of that process and there are many is General Electric which at one point was the largest market value business in the world but now is a shell of its former self.

The current bunch of the large cap universe could be an exception but history says otherwise. There is always something around the corner that would dislodge the hot ones of today. It might take longer but it’s going to happen.

Plus a portfolio invested only in the S&P 500 index leaves out stalwarts like these and 3,000+ others…

Not a collection that screams of deep value but it is a collection.

So what’s a flavor of depth and breadth? Maybe this…

That’s for domestic equities. The ingredients and the proportions can change based on where you are in life but seems even-keeled and at least pointing in the right direction. You do something similar for international equities. Then you bring in bonds and cash, real estate and alternatives. Now that’s salsa.

On bonds, the last 40 years have been the best 40 years in the history of the fixed-income world. That’s not going to be repeated so caution on what type and duration to own is warranted.

And the portfolio you design should be a function of how much you’ve saved, what you’ll continue to save plus growth in value. Expecting just your portfolio to do the heavy-lifting without a pitch from your savings is not going to cut it in this yield-starved world. Encounter anything that promises that, run.

And last, as Carl Richards, the author of The Behavior Gap says, you can have the best portfolio ever designed in the history of the world and you make one behavioral mistake a decade, you might as well have stuffed all that cash in a mattress.

So don’t.

Thank you for reading.

Until later.

Cover image credit – Karolina Grabowska, Pexels

But why does this happen? To answer that, let’s think about what it would be like to have the opposite of that and that’s deflation. If the prices of goods and services were to fall every year instead of rise, you’d wait to buy whatever you were in the market to buy because it’s profitable (for you) to wait. You’ll be able to buy the same stuff cheaper tomorrow or next month or next year than today. So it’s great for you but if everyone started doing this, the overall demand for stuff in the economy will fall. If demand falls, businesses would have to cut expenses and with their biggest expense being people, many will lose their jobs. No job means no income and no income means no spending. So demand reduces even more and a vicious cycle sets in that can swallow an otherwise healthy economy. 

So an all-out deflation is bad but then is it always that bad? Let me explain with something that just transpired. My crazy dad was in the market for a standing desk to make working from home easier (and healthier) so he looked around to see what fits his budget. But just as he was about to buy a desk, he realized that he could improvise with the desk he already uses. A construction crew around our house left behind some dirty paint buckets that were supposed to be recycled. But we all should know by now that recycling is a myth, sold by the plastics industry. A very tiny fraction gets recycled if it does at all with the rest ending up in landfills.

So back to those buckets, oh they were real dirty and hence needed to be cleaned to make them be a part of his setup. But then he could have easily bought those buckets to be used as a foundation for his existing desk for say $3 a piece (he needed 4 of them). 

But instead, a minimalist that he is who hates waste, especially of the plastic kind, he cleaned those buckets and is using them as a pretty solid base for his standing desk.

But how does this one small decision trickle through our economy? In the process of DIYing his standing desk, he deprived the stores selling the desk and the buckets from making a profit. So both these businesses got impacted (though by a tiny amount) with this one decision. But multiply that by a thousand and now the stores are hurting. If stores are not doing well, they’ll have to cut expenses and maybe, they’ll resort to laying off employees. Once laid off, the employees then stop consuming and in turn, starting a chain reaction that impacts the entire supply chain.

So my dad’s decision to not consume is great for the environment but not so great for the economy.

Now let’s talk about Japan. Since the bursting of the twin real estate and stock market bubbles in 1989, the economy hasn’t been able to recover. The country since then has been mired in a deflationary spiral and with that comes fewer and fewer available jobs so it becomes harder to raise a family. So folks are delaying getting married and are having fewer children. Fewer people means less demand. So when goods are produced at the same rate and the demand declines, prices drop and deflation becomes ingrained in the system. That’s today’s Japan.

But increasing demand through population growth is not the right recipe, especially in light of the resulting environmental impact. What would be ideal is to grow demand with the global population we already have by uplifting the billions who are currently not enjoying anywhere close to the standard of living we in the West do. That’s fortunately changing for the better but we have a long way to go.

Deflation did once visit the United States post the stock market crash of 1929 when a lot of people lost a lot of money all at once. And since most of that money was borrowed money from the banks, a system wide banking collapse ensued. Thousands of businesses failed and unemployment skyrocketed to up to 25%. People who still had jobs just froze and stopped spending, setting off a deflationary spiral just like what Japan encountered many decades later. But fortunately or unfortunately, the economy was rescued out of that spiral through government spending on the Second World War effort.

So an increased savings rate in general is deemed good but when everyone starts to save all at once, things can get real bad, real fast. That’s what economist John Maynard Keynes once described as the Paradox of Thrift where it’s great in the long run if people save money but if they do it all at once, it can have disastrous consequences. 

So now we know why we don’t want deflation but what about inflation? Prices of goods and services rise over time but why? And is that good? 

Inflation in an economy is sort of intentional and is designed by the Central Bank of a country. Central Banks control the money supply in such a way that there is always a little more money in the system in any given year chasing the same quantity of goods and services in an economy. So what does that do? It causes prices to rise by just enough so that demand for stuff in an economy is always present. And because stuff gets more expensive over time due to inflation, people will not wait to buy what they need for better prices tomorrow or next month or next year. This keeps the businesses busy producing the stuff people need, employees employed and the economy stable.

So now that we know that inflation is going to be ever present, how do we make sure that it doesn’t hurt us in the long run? I mean how do we keep our purchasing power intact over time so we can buy the same amount or more stuff tomorrow, next month, next year and decades from now? 

Inflation rate in the United States historically has averaged at around 3% so if we want to make sure that we can buy the same amount or more stuff, we will have to beat that rate over time. Depositing our savings in a bank could be one option but banks don’t usually pay interest more than the rate of inflation so that’s not an option. So what do we do?

Let’s take that In-N-Out Burger’s situation for example. Say the cost of potatoes that’s used in making fries rise due to inflation. What would In-N-Out do? They can keep the price of the fries you buy the same but if they do, their profits decline. And if they keep doing that year after year, they can start to lose money. And no business exists to lose money. So they raise the price of those fries to compensate for the increase in the cost of potatoes to keep the profits the same. And sometimes they improve their process to make fries faster and better to meet demand or they offer different types of fries at a higher price. All these things increase profits which increase the value of that business. And if you own that business, not only do you match inflation but in the long run, you are likely to beat it.

So how do we own businesses? Through the stock market where pieces of thousands of businesses are on sale every day. All you have to have is some savings to go out and buy them. 

But a very high inflation rate (hyperinflation) is not good either. That causes the prices of goods and services to rise much faster than the supply. And why is that not good?

Say you are in the market to buy a laptop. If you believed the price of that laptop would be 20% higher next week, what would you do? You’d go out and buy that laptop right away. Not only that, sensing that the price will rise by that much in a week, you’d buy 10 laptops. Why? You’d keep one for you for sure but the remaining nine, you’d sell at a profit next week. And if everyone did that, the stores would run out of stuff with no one able to buy anything, especially if the supply can’t keep up. I think you get the point.

So both deflation and hyperinflation are not good though you could live with a bit of deflation here and there. What we ideally want instead is a Goldilocks type of economy where the price of all the stuff we consume does not drop like crazy and does not skyrocket like mad either. It just chugs along.

So that’s all for now. Thank you for reading.

Until later.

Cover image credit – Retha Ferguson, Pexels

How do I know? Let’s run through some of the events the world has persevered through and yet capitalism marched on. The plot below is the growth of a dollar invested towards the end of 1914 in a basket of U.S. stocks and left there untouched since.

That story likely repeats for global stocks as well but because of limited data going that far back, we’ll use the data we have as a proxy.

And all these markers are events, mostly bad where if we were in the midst of them, we had every reason to bail. But had we not and remained invested, we did well.

Also, the y-axis above is log scale so those bumps that appear to be baby bumps are in fact deep craters that almost looked like it was the end of the world. But we are still here. You are still here.

A cursory look at the market returns we would have to endure through to get here.

These are annualized returns that measures the value of a dollar invested from the start of each year to the end of that year. This does not capture the intra-year (within that year) volatility which many a times is massive. What I mean by that is that we might end a year with say a 7% portfolio return but we would have endured a 30% intra-year drawdown first to eventually recover enough and avail of that 7% return.

And that has happened and will continue to happen. Persevering through that and sticking to our well-crafted investment plans is the only choice we have. And that is the right choice.

It’s one thing to look at the annualized returns and think, no biggie. I can handle that.

But a year is a long, long time watching the value of our portfolios decline day after day, month after month. Only when passing through that phase do we really realize how excruciatingly painful it is. We are likely experiencing that now. But endure through that we must. That is part of the deal.

If one year decline is rough, multi-year declines like the period post the Dot-com crash or the 70’s bear market or during what we had to endure through during the Great Depression is 10x worse. Things eventually recover but we have to continue investing through that by sticking to our plans no matter what. That is the only choice. And that is the right choice.

But who has a 100-plus year timeframe to invest? Okay, so let’s break this timeline into smaller chunks.

1915-1950

Why the quote unquote around only? Let’s chronicle the events that transpired during this time span to find out. And a 35 year timeframe matches a typical career span so even better.

1914 Austrian Prince Archduke Francis Ferdinand travels to Sarajevo to inspect the imperial armed forces in Bosnia and Herzegovina, annexed by Austria-Hungary in 1908. The annexation had angered Serbian nationalists who believed the territories should be part of Serbia. A group of young nationalists hatch a plot to kill the Archduke during his visit to Sarajevo. After some missteps, 19-year-old Gavrilo Princip was able to shoot the royal couple at point-blank range while they traveled in their official procession, killing both almost instantly. The assassination sets off a rapid chain of events as Austria-Hungary immediately blames the Serbian government for the attack. As the large and powerful Russia supported Serbia, Austria asks for assurances that Germany would step in on its side against Russia and its allies that include France and Great Britain. On July 28, Austria-Hungary declares war on Serbia and the fragile peace between Europe’s great powers collapses, beginning the devastating conflict now known as the World War I.

1914 The outbreak of war forces NYSE to shut its doors on July 31, 1914 after large numbers of foreign investors start selling their holdings in hopes of raising money for the war effort. All of the world’s major financial markets follow suit and close their doors by August 1. It would be about 4 months the markets remain closed. Imagine that happening today.

1915 One millionth Ford automobile rolls off the assembly line. Concerns around the fact that the demand for oil will outstrip supply and that the world will run out of oil soon. And then what? The Peak Oil theory will remain a concern like forever and here we are today with the likes of Tesla relegating the fact that the world will ever run out of oil as a non-issue. Stocks gain 81% that year.

1915 The Armenian genocide. Between 600,000 to a million dead.

1917 U.S enters the war. Stock market declines by 22% that year.

1918 Worldwide influenza pandemic strikes (Spanish Flu). It continues till December of 1920 infecting around 500 million people, a quarter of the world’s population. Estimated death toll ~ between 17 million to 50 million and possibly as high as 100 million, making it one of the deadliest pandemics in human history. An estimated 675,000 Americans die. Stocks gain 11% that year.

1918 Germany signs the Armistice at Compiègne ending World War I. 20 million dead worldwide with 21 million wounded.

1918 Russian revolutionaries execute the former czar and his family leading to a Russian Civil War between Reds (Bolsheviks) and Whites (anti-Bolsheviks). Reds win in 1920 and hence the onset of worldwide communism.

1927 German economy collapses. Stocks gain 37% that year.

1929 The stock market crash on Oct. 29 marks the start of the Great Depression and sparks America’s and likely the world’s most famous bear market. The S&P 500 falls 86 percent in less than three years and does not regain its previous peak until 1954 (in price). Stocks decline 8% that year.

1930 Unemployment soars, trade suffers from Smoot-Hawley tariffs. U.S. imports from and exports to Europe fall by some two-thirds between 1929 and 1932 while overall global trade declines by similar levels in the four years that the legislation is in effect. Stocks decline another 25% that year.

1932 Six million die in Soviet famine. Stocks continue their decline (another 9%) after a horrific 44% decline the year before from the already depressed levels.

1933 Germany and Japan withdraw from League of Nations. Stocks soar 50%.

1934 Dust Bowl problem continues. The worst drought in 300 years plagues 75% of the country. Stocks remain almost flat for the year.

1935 Nazis repudiate Treaty of Versailles. Stocks gain 47%.

1937 Beijing falls to the invading Japanese forces. Stocks decline 35%.

1938 Hitler annexes Austria. A 29% stock market gain.

1939 Germany invades Poland. Stocks close flat for the year.

1940 France falls under Nazi occupation. Stocks decline 11%.

1941 Pearl Harbor attack. US enters World War II. Stocks decline another 13%.

1944 The Battle of the Bulge called “the Greatest American battle of the war” by Winston Churchill. Fought in the Ardennes region of Belgium, this was Adolf Hitler’s last major offensive in the war against the Western Front. Hitler’s aim was to split the Allies in their drive toward Germany. The German troops failure to divide Britain, France and America with the Ardennes offensive paved the way to victory for the allies. Lasting six brutal weeks, from December 16, 1944, to January 25, 1945, the assault, also called the Battle of the Ardennes, took place during frigid weather conditions with some 30 German divisions attacking battle-fatigued American troops across 85 miles of the densely wooded Ardennes Forest. As the Germans drove into the Ardennes, the Allied line took on the appearance of a large bulge, giving rise to the battle’s name. The battle proved to be the costliest ever fought by the U.S. Army (about 100,000 casualties). Stocks gain 19%.

1945 Hiroshima and Nagasaki nuclear bombings. 200,000 dead. Stocks gain 36%.

1946 Worst work stoppages since 1919. Less than a year after the end of World War II, stock prices peak and begin a long slide. As the postwar surge in demand tapers off and Americans pour their money into savings, the economy tips into a sharp “inventory recession”. Stocks decline 8%.

1950 North Korean communists invade South Korea. Stock market gains 31%.

So this 35-year timeline that includes the Great Depression, two World Wars, pandemics and every unimaginably bad thing that could have ever happened to this world and we still came out okay being invested in capitalism.

And if there was ever such a thing as financial planning in those days and you panicked and deviated from the plan you had in place and sold at any point in time, well that would have been a sin. Not the greatest of sins but a sin. Why?

The financial underpinnings of the world were still in the early formative stages. The Federal Reserve bank that acts like a stabilizing force during times of economic upheaval today didn’t even exist up until 1913. And even when it did, there was not a lot of data and expertise on how to navigate around pandemics and wars and recessions. Everybody was learning. The system was learning with the world waffling back and forth between two distinct economic systems.

So you were forgiven if you had committed that ultimate sin but had you not and dollar cost averaged into the markets during those 35 years by investing a dollar each year, this is what you’d have.

So instead of $15, you end up with an amount 13x more. That’s hail to the power of an ironclad gut, a long-term mindset and dollar cost averaging. And notice that reduction in volatility because of your consistency in adding to your portfolio no matter what.

Let’s finish off this timeline thingy by recounting the major events that happened 1951 hence and the journey of that dollar that you (or your prescient ancestors) started in 1914.

1951-2020

1951 Seoul falls to Communist forces. Stocks gain 24%.

1953 The Korean War ends with the signing of the Korean Armistice Agreement. The agreement creates the Korean Demilitarized Zone (DMZ) to separate North and South Korea and allows the return of prisoners. However, no peace treaty is signed and the two Koreas are technically still at war, engaged in a frozen conflict. The Korean War is relatively short but exceptionally bloody. Nearly 5 million people die with more than half of them, civilians. Almost 40,000 Americans die in action in Korea with more than 100,000 wounded. Stocks remain flat for the year.

1957 Asian Flu Pandemic (a Chinese origin H2N2 avian influenza) claims 2 million lives. Stocks decline 10% that year.

1958 The Great Chinese famine kills 30 million. Stocks gain 44%.

1959 The Cuban Revolution – communism at America’s doorstep. Stocks gain 12%.

1961 The Bay of Pigs invasion – a failed attempt at ousting Fidel Castro from power. Stocks gain 27%.

1962 Cuban missile crisis sparks Cold War jitters. President Kennedy is assassinated. Stocks decline 9%.

1964 U.S. involvement in the Vietnam War accelerates post the Gulf of Tonkin incident. U.S. also conducts large-scale strategic bombing campaigns against North Vietnam and Laos. Stocks gain 16%.

1968 The Tet Offensive. American public’s resistance to the Vietnam War grows. Despite heavy casualties, North Vietnam achieves a strategic victory with the Tet Offensive as the attacks mark a turning point in the Vietnam War and the beginning of a slow and painful American withdrawal from the region. Stocks gain 11%.

1973 Israel’s Yom Kippur War and the subsequent Arab oil embargo sends energy prices soaring. A lengthy recession ensues. Inflation rate tops 10%. Nixon resigns post the Watergate scandal. Stocks drop 14%.

1975 Vietnam War ends with about 1.4 million Vietnamese and 58,000 Americans dead. Stocks gain 37%.

1979 Iran hostage crisis. Stocks gain 19%.

1980 After nearly a decade of sustained inflation, the Federal Reserve raises interest rates to nearly 20 percent, pushing the economy into a recession. The combination of high inflation and slow growth (stagflation) was a big factor behind Ronald Reagan’s victory over President Carter. Stocks gain 31%.

1983 Terrorist explosion kills 237 U.S. Marines in Beirut. Stocks gain 22%.

1987 Black Monday. Dow falls 22.6% in a single day, the worst in one day since the Panic of 1914. Yet, while the days after the crash were frightening, by early December, the markets bottom out and a new bull run commences. Stocks go on to not only make back all the losses but end the year +6%.

1990 Iraqi troops invade Kuwait. Stocks decline 3%.

1991 The Persian Gulf War. Stocks deliver a 30% return.

1997 The Asian currency crisis. The crisis starts in Thailand on July 2nd with the collapse of the Thai baht after the Thai government is forced to free-float the baht due to lack of foreign currency reserves that previously supported its peg to the U.S. dollar. Capital flight ensues almost immediately beginning an international chain reaction. At the time, Thailand had borrowed heavily that made the country effectively bankrupt even before the collapse of its currency. As the crisis spreads, most of Southeast Asia and Japan see slumping currencies, devalued stock markets, depressed real assets and a precipitous rise in private debt. Stocks earn 33% that year.

1998 The Russian financial crisis. Long Term Capital Management blows up on excessive leverage. Stock market gains 28%.

2000 The bursting of the Dot-com bubble. Stocks decline 9%.

2001 September 11 terrorist attacks. Stocks decline another 12%.

2003 The 2nd Iraq War begins. Stocks gain 28%.

2005 Insurgency spreads. Stocks gain 5%.

2007 A long-feared bursting of the housing bubble becomes a reality and the rising mortgage delinquency rate quickly spills over into the credit markets. By 2008, Wall Street giants like Bear Stearns and Lehman Brothers start toppling and a financial crisis erupts into a full-fledged panic. By February of 2008, the market falls to its lowest levels since 1997. Stocks earn 5% that year.

2008 Lehman Brothers files for bankruptcy. The global financial system is on the verge of collapse. Stocks end the year down 37%.

2016 Donald Trump elected President. Stocks gain 12%.

2018 End of the year stock market decline approaches 20%. Stocks end the year down 4%.

2020 The ongoing Coronavirus pandemic. A 26% decline so far.

I understand any amount of chronicling of history is not enough in light of the mayhem we have seen in the markets and in our portfolios lately. And these are also the times that remind us of the role bonds and cash play in our portfolios if drawing income to live on is a necessity. For the rest of us, we did right by sticking with the portfolios we own.

But these are also the type of events that separate us from folks who commit the ultimate investing sin if there was ever and that is to panic sell. There is no reason to and there is no need to. Granted, there will be some restructuring in the global economic landscape in light of this pandemic. Weaker companies will fail and the stronger ones will come out even stronger than before. And you don’t want to be there picking winners and losers because you are statistically much more likely to own losers than winners. You want the market to sort this out and it will over time.

This world of ours has endured far worse and we see that. We would come out of this just fine. I bet we would be looking back in a decade on this entire episode and say that was nothing. The world has seen far worse. 

And if you are in your twenties or thirties or even in your forties and you are new to this market volatility, I say this: you will have many such episodes in your life when your portfolio massively declines in value, sometimes for a reason and other times, without any. But you have to remain invested because that is part and parcel of this whole process of getting from point A to point B and beyond.

And for the finance nerds out there, when we invest in stocks, we are in fact buying perpetuities that promise to deliver a stream of cash flows this year, next year and many years beyond that, discounted at an appropriate discount rate to the present day. This episode we are living through will impair a few years’ worth of those cash flows but the longer term cash flows will eventually come through. They have to.

Markets tend to overextend on the way up and on the way down. That’s natural. But remember, things are never as bad as they seem when all hell is breaking loose and you are in the midst of that. At the same time, things are never as good as they seem when everything is going great.

So plan for things to go bad when things are going well. And when things look miserable, keep in mind that things will eventually get better.

So don’t go crazy not having any safety buffer to tide you through in situations where your income gets disrupted temporarily. At the same time, don’t panic.

And if you are a market participant (you have to be, you have no other choice), you’ve got to own stocks. There is no plan you can theoretically design in today’s interest rate environment where you can avoid that asset class completely. But when you do own stocks, you’ve got to be prepared for declines every now and then because as Charlie Munger says…

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament and who can be more philosophical about these market fluctuations.”

Not sure about being philosophical…okay, I can be a bit philosophical but if it makes you feel any better, this is a small collection of businesses amongst the thousands you own if you own a global market portfolio. And they are selling at a discount. So buy if you can.

Some companies will burn and die but capitalism will survive. It has to because… Pascal’s Wager?

The only folks who get absolutely demolished in bad times are the ones who take on excessive leverage. The only leverage that you should very reluctantly sign up for in your own personal life is your home mortgage. And very, very reluctantly at that.

And leverage, especially with stocks, never. Because I am with The Oracle on this…

“It’s insane to risk what you have and need for something you don’t really need. You will not be way happier if you double your net worth.”

And Black Swan events like these is when we see the folks flirting with leverage get completely wiped out. Those 10 AirBnB rentals that you thought you could lever up and make a killing? Not happening. That’s the nature of blind risk and capitalism has a way to cleanse the system every once in a while. That’s ultimately healthy but you don’t want to be a part of that process.

But never in my wildest imagination did I predict these unfolding of events not only with the markets but with our lives. I have been hoping and praying that there would be a correction to clean out the excesses because I feared that the longer the good times rolled, the more remote a chance of a decline will seem, the more overconfident investors will feel and the more risk they’ll take. Which means that that eventual fall, which is a near certainty, would be far more deep and wide.

But what about all those folks who got out just in time before the markets crashed and will likely get back in before they recover?

Yes, of course. And I have a bronze colored bridge I’d like to part with at the right price.

You might get lucky timing the getting out part once or maybe twice in your life but you also have to get the getting in part right. And markets don’t usually recover when you think they’ll recover. They make big and sudden moves which will catch you off-guard and you then miss the boat. Plus these moves tend to happen at the bleakest of times when all hope is lost.

And say you got out in time before the crash and you got back in at the bottom. So you got lucky twice. What’s the lesson you learnt? That the moment you have that inkling of a disaster on the horizon in the future, you’ll get out. And that disaster never happens. Or it happens but it’s not as severe and the markets zoom past the point you sold. What happens then? You wait? Wait for a decade?

Because that is precisely what many investors did this past decade and hence missed out on all those gains before these recent spate of events.

So don’t mess around. Remain invested.

Good investing is a lot about psychology and behavior combined with a decent dose of history with a sprinkle of math and finance. Any one of them missing from the mix and it’s going to be real hard to meet your goals.

And getting sucked into a fad here and a fad there and assembling investments with no particular rhyme or reason beyond hoping that you buy low and you will get to sell higher is not what it’s all about. I have seen folks talk about this airline stock or that cruise stock. Fine. A few of them will work out but what’s the definition of working out? A double or a triple? Pre-tax?

And you for sure didn’t stake the kind of money that’ll change your life. So if you didn’t, don’t bother. Stick to your plan.

I am not saying you have to but maybe you’ve got to have someone who knows these things watch over your financial life. Because as Phil Demuth, author of several excellent books and the founder of Conservative Wealth Management opines…

“If you manage your own money, you are potentially vulnerable to every crackpot investing idea that comes along. It only takes one.”

Only one. Maybe you will but most don’t get many shots at this. So act wisely.

And what I am truly worried about is the long-term health of our retirement system because when I see stats like an average retiree nearing retirement has only $50,000 saved, I say holy s#*@. We are screwed. Because as William Bernstein says…

“I’ve flown airplanes, and as a doctor, I’ve taken care of kids who can’t walk. Investing for retirement is probably harder than either of those two activities, yet we expect people to be able to do it on their own.”

And that’s why we all yearn for those pension systems of the past where we had someone other than us pool assets together with our fellow savers and design a plan with enough safeguards to make sure that the money lasts longer than any of us individually.

That don’t exist and we’ll have to live with that. In the meantime, a few tips to navigate around this and future market turbulences.

• Always, always keep emergency reserves that cover at the minimum 6 months of living expenses. And depending upon the type of work you do, maybe you need more but 6 months is the ideal minimum. Granted, it is a tall order for many folks who cannot afford to set aside literally anything because they can’t. But I know you can. How? Because you got this far reading this.
• Never panic. You will encounter many a market crashes and recessions through your investing life. You just have to acknowledge that fact and design a plan that lets you survive those events. You need to realize your own volatility to heartburn ratio and this is the time to take notes. The higher that ratio, the more equity risk you can handle and the higher the returns you can expect. A lower ratio means that you’ll sleep alright but then you have to be prepared to save ungodly sums of money to maintain the same standard of living as before through a likely long retirement.
• It’s obvious but try to avoid taking on too much debt of any kind, especially of the lifestyle kind. Screw that big home with an albatross as a mortgage if it bogs you down. It’s unfortunate that we as a country through our tax policies and incentives have turned shelter into an asset class. And a retirement plan. That’s stupid and real bad in the long run, not only for you as a home owner but also for future economic growth. And environmental costs aside, it locks people in place, decreases social mobility and increases risks in the system and in our lives. Let others participate in this game but you remain mindful of the debt you take on.
• Never borrow and invest, ever. We’ll see the repercussions of that soon as a lot of over-leveraged real estate ventures and businesses go belly up. I mean all these folks were running their ’empires’ in a way that they could not sustain a couple months of income disruption? Come on.
• And stay far, far away with that mindset of Keeping Up with the Joneses. Design your life around being happy with as small an overhead as possible. The freedom and the peace of mind that comes with that will be priceless. You’ll sleep better, play better and work better. All good.

So that’s all I have to say for now. Thank you for reading.

Until later.

Cover image credit: Josie Stephens, Pexels

Now that you’ve got that right, a few obvious things first. If the rate of return is higher, your double will happen quicker. On the flip side, if it took you a lot less time to double your money, you know that you earned a high rate of return. So it would take a lot longer to double your money if it grew at a rate of 2% a year as compared to say 10%. And with this rule of 72, you can see that $100 growing at 6% will take 12 years to double (72/6). At 10%, 7.2 years and at 12%, 6 years.

Okay, you’ve got that now so how do you use this nifty little rule in helping you make daily spending decisions? Say you are 15 and a new gadget you desire just came out and it costs $250. You worked hard and earned and saved enough money to buy that gadget. No issue there. But that last year model you own works just fine but regardless, you go in for the kill. I mean you buy it. But was it really worth spending 250 bucks for a new one? Granted, it runs a bit faster, looks a bit nicer but was it truly worth it?

And what happens to the one you already own? It gets recycled, hopefully. Most likely, it’ll end up in a landfill. And then over time, that thing starts to decompose if it ever does. And the chemicals from that thing start to leak into the water (#savetheturtles) which at some point finds its way through the tap, into your Hydro Flask and into your body. So all bad.

But I digress, that money I just spent and almost destroyed the environment in the process could have instead been used for a more worthy goal. Like to fund a business idea to clean the environment in say ten or twenty years which by then, I would hopefully know enough on how to do it. Or say to someday be able to not work for money at all and work because I want to make a difference. So at 7%, that same 250 bucks would turn into $500 in 10 years. How did I get to that so quick? That rule of 72 (72/7 ~ 10 years) again. 10 more years and we are talking about another double. In 40 years, that same 250 bucks that I had no reason to spend to replace a perfectly working gadget at 7% would be 8,000 BUCKS. So I had a choice and I blew it.

And I am not implying that you need to become a monk and give up on things. All I am saying is to be conscious about how and what you spend your savings on and how it’ll impact your future and the world.

My advice, if you are about to buy anything that feels discretionary is to not buy it on the spur. Give it some time and come around in say a couple days and see if you still feel a need for whatever you were about to buy. If yes, buy it. If not, even better.

And don’t forget the rule. Keep a rate of return in mind and see how many doubles you are missing out on if you don’t defer that purchase. Your future will be bright and so will be our world.

Until later. 

Cover image credit – Artem Beliaikin, Pexels

But why does this happen? Well just imagine what it would be like if we had the opposite of that and that is deflation. If the prices of goods and services fell every year instead of rising, you’d wait to buy whatever you were in the market to buy because its profitable (for you) to wait. You’ll be able to buy the same stuff cheaper tomorrow or next month or next year than today. So it’s great for you but if everyone started doing this, the overall demand for stuff in the economy will fall. If demand falls, businesses that provide us with those products and services will see their revenues and profits fall. That would then lead them to cut expenses with their biggest expense being people. So people will start losing jobs and no job means no income and no money to spend. So the demand reduces even more and the cycle continues downhill until deflation is countered. 

A prime example of what deflation could do to an economy is Japan. Since the bursting of the twin real estate and stock market bubbles in 1989, the economy hasn’t been able to recover. The country is currently stuck in a deflationary spiral ever since where fewer jobs are causing the demand to stagnate with folks delaying the purchase of stuff. Less number of jobs also causes the population to decline because without a job, supporting a family becomes a challenge and hence folks are delaying marriage and having fewer babies. That adds to a further reduction in demand. And when goods are produced at the same rate and the demand is falling, prices drop and the deflationary environment continues. 

Something similar occurred in the United States post the stock market crash of 1929 where a lot of people lost a lot of money, banks closed down, and the entire financial system came to a standstill. Businesses started shutting down, laying off workers setting that process of deflation in motion. Spending in the economy just didn’t stop because of people losing jobs but even the fear of losing jobs caused the rest of the people to shut their wallet tight, further reducing demand. That’s what John Maynard Keynes described as the Paradox of Thrift where it’s great in the long run if people saved money but if they do it all at once, things can get real bad real fast. 

So now we know why we don’t want deflation but what about inflation? Prices of goods and services rise over time but why? That’s because inflation in an economy is sort of intentional and is designed in by the central bank of a country (the Federal Reserve for example in the U.S.). The central bank of a country controls the money supply in such a way that there is always a little more money in the system chasing the same quantity of goods and services in an economy. What does that do? It causes prices to rise by just enough so that demand for stuff in an economy is always present. And because stuff gets more expensive over time due to inflation, people will not wait to buy what they need for better prices tomorrow or next month or next year. This keeps the businesses busy producing the stuff people need, employees employed and economy stable. 

So now that we know that inflation is going to be ever present, how do we make sure that it doesn’t hurt us? I mean how do we keep our purchasing power intact over time so we can buy the same amount or more stuff tomorrow, next month and next year. Inflation rate in the U.S. has historically averaged at around 3% so if we want to make sure that we can buy the same amount or more stuff, we will have to earn more than that over time. Depositing our savings in a bank could be one way but banks don’t usually pay interest more than the rate of inflation. So a better way would be to invest our savings into investments that tend to outpace the rate of inflation over time. And that in theory means owning stakes in businesses that produce the stuff we buy and consume.

For a perfect and well-balanced economy, we don’t want deflation or hyperinflation. Instead, we want something like a goldilocks economy where the prices of goods are not dropping like crazy and not skyrocketing like mad but just right.

Until later.

And we know that quote we still remember him by, “A penny saved is a penny earned.” But he is also known for another quote that describes the process of compounding as best as one can. That quote, “Money makes money, and the money that money makes, makes money.”

He died in 1790 and bequeathed his life savings, a cool $10,000 (of that time so big money then) to be equally split between two of his favorite cities, Boston and Philadelphia but with a condition. The first half of that money should be invested and should remain invested and can only be used after 100 years. The second half needs to remain invested and can only be spent after 200 years.

And that’s what the cities did. In 1890, at the end of the first 100 year period, both cities used $500,000 each to be spent on public goods. That’s what 100 years of compounding $2,500 that each city received does. The calculated rate of return to turn $2,500 into $500,000 after 100 years ~ 5.44%. So very ordinary.

And here are the numbers over time…

So that was the first 100 years.

In 1990, both cities got access to the rest of the money. Any guesses on how much the other half grew to? How about 20 million bucks and that’s for each city. So that’s 200 years of compounding the remaining $2,500 that was bequeathed to each city.

And the annual rate of return required to turn that ‘tiny’ sum to 20 million bucks? 4.6%. Again, pretty average. In fact, that’s below average historically and yet the result, extraordinary.

And when you are dealing with 200 years of compounding, a tiny change in the rate of return makes a big difference in what you get at the other end. Go ahead, pull out that spreadsheet and give it a try.

So time truly is magical. But the first step to compounding is to have something saved to compound. You could be the greatest investor who ever lived but zero dollars will still be zero dollars regardless of the rate of return. So save.

And to find out how much your savings will grow to at some future date, you can use this little bit and the only bit of math here and ever.

FV = PV (1 + r)^t

FV is the Future Value of your savings

PV is the Present Value

r is the rate of return

t is time

I love playing around with this by trying out different values for the rate of return and time. Let’s try one. Say I had 100 dollars (PV) saved and I bought an investment with an annual rate of return of 6% (r) and I invested that money for say 5 years (t), I’d have a total of $134 at the end of that 5 year period. Just plug the numbers into the equation and solve for whatever you are trying to find out. In this case, we want to find FV like below.

FV = $100 (1 + 0.06)⁵

But compound interest is slow and boring…at least at the start.

And here’s what I mean. Say you are 20 and you start setting aside $500 each month and invest that at an 8% rate of return each year and you do that for 45 years (till you are 65), this is what you’ll have…

But just look at these numbers…

• 20 years in, you invested $120,000 and you earned $176,538. Big deal but then, no big deal.
• 40 years in though, you invested a total of $240,000 but you earned $1,438,686. Now that’s something.

This compounding thingy really starts to become fun only after a couple decades.

Here’s another more fun example. Say at 15, I start a business and I clear $3,000 in profits that year and I do that for 5 years. Now a saver that I am, I don’t spend nothing all those years so at the end of five years of toiling, I accumulate $15,000 in total. And say that’s all the savings I’ll do through my life. Not likely but let’s assume that. And I don’t need the money because I get to live and eat and have fun for free (how? that’s a secret). So then what do I do? I go to my dad to ask for advice and since I don’t need the money for a long, long time, he recommends investing the entire amount in a global portfolio of stocks.

My sister on the other hand, in her attempt at imitating me, does the same exact thing. She starts a business when she turns 15 generating the same amount of profits each year. But a spendthrift that she is, she spends it all. At 25, she gets to have a peek at my account and she realizes that she is falling behind in terms of all this savings thingy so she starts and continues saving till she is a grand old lady at 65.

And like me, she also seeks advice from our dad on where and how to invest her savings and THE dad that he is, recommends the exact same portfolio. I started 10 years earlier and I saved and invested only $15,000. My sister started 10 years later but she saved and continued investing till she reached 65. So she invested a total of $120,000 (40 years x $3,000 each year). Who wins? Of course I do.

Because I got a 10 year headstart, my little sis could never catch up with me even after saving 6x more. That’s the secret I was talking about.

Thank you for reading.

Bye.

Cover image credit – iheitlager, Flickr

Later that year, the Raja held a feast and invited some of the richest people in his kingdom. He ordered his servants to carry the rice from the storehouse to the grand feast. As the servants carried those sacks of rice, a woman saw that some of the rice was spilling out of a sack so she cupped her hands and collected the rice. The Raja saw what she was doing and screamed, “You thief! Hand over all the rice you just collected.” The woman simply replied, “I didn’t steal any rice. The sack your servants were carrying had a hole in it and I was going to give the rice that fell out back to you, your highness.” “Very well then,” the Raja said, “because of your honesty, I would like to grant you a wish. You can ask for anything you desire.” The woman thought for a moment and said, “I would like you to give me a grain of rice on day 1, a double of that on day 2, a double of day 2 rice on day 3 and so on for 30 days. That is, I wish for one grain of rice to double every day for 30 days.”

The Raja smirked at the wish and immediately agreed without knowing what he was getting into. By the 10th day, the Raja gave the woman five hundred and twelve grains of rice. “This woman is so stupid. She barely asked for anything,” thought the Raja. As the 21st day rolled around, the Raja gave the woman one million, forty eight thousand, five hundred seventy six grains of rice. The Raja glanced nervously at his shrinking stockpile of rice. As the 30th day rolled around, the Raja gave that woman five hundred and thirty-six million, eight hundred and seventy thousand, nine hundred and twelve grains of rice. Towards the end, the woman owned all the rice in the storehouse and she immediately distributed it amongst all the hungry people in the kingdom. This taught the Raja a couple of valuable lessons and that is…Don’t Be Greedy and…

This Compound Interest Thingy Is Truly Magical

Let’s say that I have $100 saved and since I really don’t have a use for it (my dad buys all the essential things for me…thanks dad ), that money can remain in my piggy bank. Or I could take my savings and build a product that I know kids my age will love and use. And say $100 is just the right amount of capital needed to fund that enterprise. So I do that and lo and behold, my business generates a 10% profit in its first year of existence. That is, the business generates a $10 profit on my $100 of the initial investment. The value of my business now is $100 in seed capital + $10 in profits = $110 at the end of year 1. I have a choice to make now. I could take that $10 that my business generated in profits and blow it on say cotton candy or if I really knew what I was doing and there was still unmet demand for my product, I would reinvest those profits back into my business. I decide to do the latter and in year 2, the business generates another 10% profit. But now, that 10% is on $110 and the value of my business at the end of year 2 is $121. And if I decide to continue to reinvest the profits back into the business, at the end of year 3, the value of my business will be $133, at the end of year 4, $146 and in year 5, $161.

So you see how the value of the business is not growing by just $10 each year but is accelerating at a faster and faster rate. That’s compound interest at work. That’s exponential growth where money makes money on money. It starts off slow and then it just takes off. If my business continues to flourish, by year 10, the value of my business at that same rate of profitability will be $259. But through all this, if reinvestment into the business was not a possibility for whatever reasons and I took those profits out each year and kept it in say my piggy bank at home, my net worth will be just $200; $100 from the value of the business and $10 each year in profits for 10 years.

And worse yet, if I were a spendthrift little brat, I could have used that $10 in business profits each year on say fidget spinners. No, on cotton candy. Anything really. And say I did that for 10 straight years, what’s the value of my business then? $100. How much total profits did my business generate? $100 but then I have nothing to show for it except maybe all the fun I had playing with fidget spinners. Or eating cotton candy .

Here’s another trivia – if you had to choose between a million dollars in a month or one penny doubling every day for 31 days, which option would you choose? You might have guessed the right one considering what the Raja just went through but then blame my dad. He loves to play these tricks on me and sometimes on my little sister from time to time but without thinking it through, I jumped at the million dollar option.

And why would you not? A million dollars versus a penny and whatever that penny was supposed to do? But later in the day, I went back to that same question and decided to see what was the big deal with 1 penny doubling every day for 31 days. And I was stunned. I tried again and again to see if I was making a mistake but I kept getting that same enormous number which was much bigger than a million. And that number was $10,737,418.

And here’s how that happened…

One penny on day one turned to two by day two, then to four on day three and so on. By the tenth day, I was looking at $5.12, just enough to buy me a burger and fries. When I first saw that number, the last thing that came to my mind was that a measly five bucks and change would turn into ten million bucks.

But it did.

So all that magic happened in the last few days of the month. And this right here is what exponential growth looks like. If we were to plot this data with days on the x-axis and dollars on the y, the curve would almost appear to be a flat-line hugging the x-axis for quite a while and then it would just take off.

Of course there’s no investment in this world where you’ll be able to double your money each and every day but we can see many examples of this exponential growth for real. Take Warren Buffett, arguably the world’s most famous investor, and his net worth for example. At age 52, he was estimated to be worth about $250 million. Three years later, his net worth jumped to a billion dollars. Another four years later, to $3.6 billion. He is now 88 with an estimated net worth approaching $90 billion. Buffett started investing at age 11 and it took him 44 years to reach the first billion dollar mark. But from a billion to 90 billion took him just 33 years. That of course is a combination of great investing and the magic of compound interest at work.

So that’s all I have for now.

Thank you for reading.

Cover image credit – Leo Cardelli, Pexels