The document discusses the power of compounding returns through examples. It shows how compounding a small amount, like grains of rice on a chessboard, can grow exponentially over time. Compounding returns from investing $100 at 10% annually for 40 years results in over $4500, much more than depositing $100 each year. The relationship between time, interest rates, and returns is illustrated through scenarios showing that higher rates and longer times lead to dramatically higher compound returns compared to cash or simple interest. Compounding is described as the key to how most wealthy individuals have achieved their success through investing.
The document discusses the power of compounding returns through examples. It shows how compounding a small amount, like grains of rice on a chessboard, can grow exponentially over time. Compounding returns from investing $100 at 10% annually for 40 years results in over $4500, much more than depositing $100 each year. The relationship between time, interest rates, and returns is illustrated through scenarios showing that higher rates and longer times lead to dramatically higher compound returns compared to cash or simple interest. Compounding is described as the key to how most wealthy individuals have achieved their success through investing.
The document discusses the power of compounding returns through examples. It shows how compounding a small amount, like grains of rice on a chessboard, can grow exponentially over time. Compounding returns from investing $100 at 10% annually for 40 years results in over $4500, much more than depositing $100 each year. The relationship between time, interest rates, and returns is illustrated through scenarios showing that higher rates and longer times lead to dramatically higher compound returns compared to cash or simple interest. Compounding is described as the key to how most wealthy individuals have achieved their success through investing.
The document discusses the power of compounding returns through examples. It shows how compounding a small amount, like grains of rice on a chessboard, can grow exponentially over time. Compounding returns from investing $100 at 10% annually for 40 years results in over $4500, much more than depositing $100 each year. The relationship between time, interest rates, and returns is illustrated through scenarios showing that higher rates and longer times lead to dramatically higher compound returns compared to cash or simple interest. Compounding is described as the key to how most wealthy individuals have achieved their success through investing.
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The Power of Compounding
Why it’s the 8 t h Wonder of the World?
A TALE OF COMPOUNDING R ETURNS
A STORY ABOUT THE POWER OF COMPOUNDING
THE BENEFITS OF COMPOUNDING
WHAT IS COMPOUNDING, AND WHY IS INVESTING TODAY BETTER THAN INVESTING TOMORROW?
TIME , INTEREST, AND R ETURNS
WHAT DICTATES YOUR LONG-TERM INVESTMENT RETURNS?
“Compound interest is the eighth wonder of the world. He who understands it earns it, and he who doesn’t; pays it.” Albert Einstein
A Tale of Compounding Returns
A prisoner waiting for his sentence to be carried out was once brought before the King for a final request. “What is your last wish?” asks the King. “I wish to make provisions for my family to survive after my death,” the prisoner replies. The King responds, “Make your request and let us be done with this.”
The prisoner replies, “if a single grain was kept on the first square and then doubled on every next square (1 on first, 2 on second, 4 on third, 8 on fourth, 16 on fifth and so on, till the 64th square), grant me the number of grains of rice on the last square of the chessboard so that I shall give it to my family before I depart!”
Thinking what a little demand, the King grants it and orders his ministers to have the rice calculated and given to the prisoner.
By the time they got halfway through the chessboard, the amount of grain was more than the entire kingdom possessed, and by square 64, the rice grains were almost 18 and a half quintillion. That’s about 5 trillion tonnes of rice!
That’s the power of compounding and exponential growth.
The Benefits of Compounding are more than you think!
Most people who don’t invest in stock markets often don’t do it because they think they lack the money. But the above story illustrates that compounding is a real-life butterfly effect where investing a single dollar can earn you a fortune. Think of the chessboard squares as years and rice grains as your money. Doubling the rice every year (square) is a 100% return.
Consider this, depositing $100 to your savings every year for 40 years, starting today, will result in $4100. In contrast, investing a hundred dollars today with a 10% compounding return and no additional deposits whatsoever for 40 years will result in over $4500!
So, what is compounding? Simply put, it is the process of repeatedly re-investing your earnings in your principal to earn an exponential return.
Why is it better? Because over larger amounts and periods, the exponential growth aspect triumphs simple investing by a long shot! If we convert the $100 in the above example to $1,000. The resulting returns are $5,000 for deposits against $45,000 for compound returns. That’s a difference of over 9 times!
The relationship between Time, Interest, And Returns Let me illustrate the power of compounding by exemplifying three very common scenarios and then see the effect of time and interest rates on the returns generated by investment in each scenario. Suppose you had $10,000 and 5-years’ time. You have 3 options:
Keep the Cash;
Invest at a simple interest rate; or, Invest at a compound interest rate
With a 5% rate of return and 5 years:
If you keep the cash, the amount is susceptible to inflation and depreciation and would stay flat at $10,000 (in the best case scenario!). If you loan it to a friend with 5% simple interest per annum, it results in a $2,500 return and a total amount of $12,500. If you lend it at 5% compound interest, the resulting total comes around to $12,762, 2% higher than scenario 2.
Cash Simple Interest Compound Interest
14000
12000
10000
8000
6000
4000
2000
0 0 1 2 3 4 5
Let’s quadruple the time horizon in the same scenario to 20 years and see how time affects compounding returns. With a 5% rate of return and 20 years:
Cash remains the same at $10,000;
Simple interest generates an additional $10,000, turning the total amount into $20,000; Compounding generates over $16,500 additional returns with a total of $26,532, over 32% higher than scenario 2!
The simple returns quadrupled in a quadruple amount of time, from $2500 to $10,000. In contrast, the compound returns generated almost 6 times higher returns simultaneously, from $2,762 to $16,532. This difference will keep rising exponentially as each year passes. Cash Simple Interest Compound Interest 30000
As you can stipulate from the above scenarios, the higher the rate of return and the time unit, the higher are total returns. I’ve summarized all the above scenarios below, and you can see the jaw- dropping difference.
The baseline is that investing is always better than not investing, and, in every scenario, investing earlier is better than investing later! And compounding returns are how every millionaire and billionaire in the world has gotten to where they are today.
