How Compounding Interest Can Work For You
Next thing I want to show you is how compound interest works. It’s interesting, we’ve had several people who’ve never even heard of compound interest. Compound interest is powerful. They can’t prove this but Einstein said that compound interest was the eighth wonder of the world. He said, “Either you can earn it or you can pay it. It’s your choice.” It’s either working for you or it’s working against you. If you know how it works and if you know what’s necessary for it to work, you’ll be able to be in control of it.
This is a very graphic example. This assumes a hundred percent compounding, which could happen but is not likely. It’s dramatic and I want you to see it because it expands it for you to really catch the idea. We start with a penny on the first day and because we’re compounding, we get two on the second day. The compounding then means on the third day we have four. The fourth day we have eight and on the fifth day, we have 16. You see the compounding? By the 22nd day, we have $20,971.
And then life happens. Life happens one day and suddenly we have a medical bill or need a new car. We put a down payment on a house or we have to send one of the kids off to college. That compounding immediately stops because we had to use that money. In life, it could have also been my money in the markets. It could have been a fund and I had a loss or reversal in the fund like 2007, 08, 09 and 10. When people’s stuff was climbing like crazy and then suddenly they had a 40 to 60% pull back. That’s an interruption in the compounding. In order for compounding to work for us, compounding has to be uninterrupted and continuous. Up until this point, it’s been uninterrupted and continuous and the penny is now $20,971. Once interrupted, we have to start over. One penny to two and at the end of 31 days we have $2.56.
Can you guess how much that would have been on day 31 if the compounding had never been interrupted?
Now you get the idea. Compounding interest can make you money but it has to be uninterrupted and continuous. The size of the compounding is not as relevant although the bigger the better. If someone is not wealthy beyond measure from their compounding interest, it’s because it’s been interrupted the markets or by life. One of the two.