Wonders Of Compounding

According to Albert Einstein, “Compounding is the eighth wonder of the world.” But with bank interest rates at record low, are we really going to sit around to wait for our money to grow in the bank? Besides, interests on deposits hardly- if ever- beats inflation. Putting your hard-earned money in the bank now would mean having less- in terms of purchasing power- to spend in the future. Simply put, keeping your money in the bank erodes its value. Consequently, financially literate individuals would turn to the stock market as an alternative to compound their money. Compounding is essentially how your money will grow over time. With the example given below, how much compounding can do to grow your cash pool will blow your mind.

Say, there are two friends of the same age, Alice and Betty. Alice starts investing at age 20. She invests $3000 yearly till the age of 30. In other words, she puts $30 000 in her portfolio over a 10 year period. Betty on the other hand, starts investing at age 30, with a yearly injection of $5000 in her portfolio for 10 years. By 40, she would have contributed $50 000 to her portfolio. Assuming both Alice and Betty are able to generate a conservative 6 per cent on their portfolio yearly, at age 40, whose portfolio would be greater?

If you thought Betty would have more in her portfolio, then let me show you the magic of compounding.

Year Alice Betty
2020 $3000
2021 $6180
2022 $9551
2023 $13 124
2024 $16 911
2025 $20 926
2026 $25 182
2027 $29 692
2028 $34 474
2029 $39 542
2030 $41 915 $5000
2031 $44 429 $10 300
2032 $47 095 $15 918
2033 $49 920 $21 873
2034 $52 916 $28 185
2035 $56 091 $34 877
2036 $59 456 $41 969
2037 $63 024 $49 487
2038 $66 805 $57 457
2039 $70 814 $65 904
2040 $75 063 $69 858

By 2040, Alice will have $75 063 in her portfolio compared to just $69 858 in Betty’s despite  Betty coughing out $20 000 more. Additionally, dividends from the stocks were excluded in this example. This means, Alice would have significantly more in her portfolio if dividends were to be thrown into the equation.

In summary, the earlier you start, the greater your rewards. Even with lower capital now, you will still be able to beat your future self- even if your future self invests more- with the power of compounding. With perseverance and time, your money would grow like you have never imagined. Like what the Dow Theory states, “Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it.” So why wait for tomorrow when you can start today?

Stay Tuned,

Aspiring Lynch

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