The power of compounding

I was recently asked to give an impromptu speech to share the words of wisdom I would give my 16-year old self.

My short speech was to explain the power of compounding.

It is an understanding I am trying to impart to my children of how compounding interest or returns work in your favour over time.

Of course, my children politely listen to me explain the power of compounding, roll their eyes and say, “Yes Daddy I understand.”  I ask questions like, “Do you want me to buy that lego set now or a car when you turn 50?”  I am not sure those questions help, turning 18 is an eternity when you are young.

Warren Buffet, the world’s third richest man, certainly understands the effect of compounding.  As a child he gained an understanding of what compounding could do and it has shaped his whole life.

It is one thing to understand compound interest but applying it is where the magic happens.  The sooner you start the greater the result. 

If you start with a thousand dollars and grow it at 10%, in five years it is $1,600, in 10 years it is $2,600, in 23 years it is $10,800.  A dollar today is worth $10 in 25 years.

The way numbers can rocket upwards at an increasing rate when growing at a constant rate is how you can turn a small amount into a fortune.  (Graphically shown by the arc in arcinvest)

I have on occasion been asked to speak to a school class about investing. “Want to be a millionaire?”  I say to the students.

Then I tell them how, start with only $100 and save $100 a month, achieve 9% pa (very achievable long term returns from the share market).  How long would it take you to be a millionaire?

It would take you 50 years. After 10 years you would only have around $20,000 and think this is useless.  At the 20-year mark,  $65,000 and at the 42-year mark, when you are likely starting to think of retirement in a few years, you would only be half way. But, the power of compounding is at work, it just keeps accelerating the value and by the 50-year mark you have hit the $1 million.   Let’s say you leave it for another 5 years you will have $1.6 million.

Buffet has been able to achieve 19% pa on his funds, by compounding the return over many years this is how he became the 3rd richest man in the world. He understood the power of compounding when he was just 10 and has been using it to grow his wealth ever since.

Contact arcinvest to learn how you can grow your wealth through long-term, reliable investments.

Posted in Investing, Money.