Spending less than you earn and investing the difference is the first thing that comes to mind. But a bigger deal is time. Let me show you why.

Say I turn 25, start working (late start much) but have no clue about any of these things. So, I earn and spend. A few years go by and just like that, I turn 30.

And then I get to see the light of what I missed and how much harder it just got if my goal was to retire with a million bucks by the time I turn 65.

I know, I know, I am still a spring chicken and thinking about retirement is something only old people do. But remember, I am old. I just turned 30.

Though it’s not late yet but we all know that the more we put it off, the harder it gets. How much harder?

At 30, to get to a million dollars by 65, I need to set aside 701 dollars each month assuming my money grows at 6 percent rate of return each year. That is lower than what the stock markets have historically returned but I like to assume the worst and hope for the best.

But say I delay it to 35 and now I have to save 996 dollars to get to that same goal. At 40, it is 1,443 dollars and then it’s over. I mean it gets exponentially harder.

The word exponential is important because if you noticed the top end of the bars, they tend to curve up and curve up fast. That’s exponential growth. That’s compound interest. Nothing magical but then it is.

Here’s another take on the power of time and systematic investing. And all we are talking about is a mere 100 dollars one time or 100 dollars a month for 50 years. Yes, there is a difference but setting aside 100 dollars each month is a manageable sum for literally anyone.

The difference in final wealth though between a one-time investment of 100 dollars versus investing that amount every month for 50 years at that same 6 percent…

Not even in the same galaxy.

And all you had to do was set aside a cup of Starbucks worth of change each day.

Thank you for your time.

Cover image credit – Ron Lach, 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

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