{"id":1611,"date":"2016-08-08T10:22:44","date_gmt":"2016-08-08T15:22:44","guid":{"rendered":"http:\/\/www.investmentzen.com\/blog\/?p=1611"},"modified":"2023-03-16T00:55:06","modified_gmt":"2023-03-16T04:55:06","slug":"why-compound-interest-isnt-as-powerful-as-you-think","status":"publish","type":"post","link":"https:\/\/www.investmentzen.com\/blog\/why-compound-interest-isnt-as-powerful-as-you-think","title":{"rendered":"Why Compound Interest Isn’t As Powerful As You Think"},"content":{"rendered":"

If you had to pick just one personal finance quote that everyone<\/strong> agrees on, what would it be?<\/p>\n

I would choose:<\/p>\n

\u201cCompound interest is the most powerful force in the universe.\u201d<\/p><\/blockquote>\n

<\/p>\n

After all, who doesn’t agree that we should save money<\/a>, invest in the markets<\/a> early, and put compound interest to work<\/a>?<\/p>\n

But as the title of this post suggests, I actually don’t think compound interest is as powerful as a lot of us think.<\/p>\n

What Did You Just Say??!<\/h2>\n

I realize that questioning the power of compound interest is basically personal finance heresy, so before you break out the torches and pitchforks, let me say this:<\/p>\n

Compound interest is extremely powerful…but there is another force that is even more powerful.<\/p>\n

Before we get into all that, let’s take a step back and look at what makes compound interest so powerful in the first place.<\/p>\n

Ever Heard Of The Magical Doubling Penny?<\/h2>\n

There are a lot of great ways to show the power of compound interest, but one of my favorites is the story of the magical doubling penny. It goes like this:<\/p>\n

Would you rather receive $1 million dollars today or receive a penny that gets doubled every day for a month?<\/p><\/blockquote>\n

As it turns out, if you choose the $1 million dollars you\u2019d be making a horrible<\/i> financial mistake because a penny doubled every day for a month is $10.7 million dollars. Even the best compound interest accounts<\/a> won’t match this in a lifetime, but it’s a helpful way to understand the concept.<\/p>\n

Funny enough when I did a Google image search for the doubling penny, I actually came across my buddy J money\u2019s<\/a> spreadsheet as the first result:<\/p>\n

<\/p>\n

Clearly, J Money is as big a fan of this little thought experiment as I am! As J Money explains:<\/p>\n

\u201cAny time you doubt the power of compounding going forward, do yourself a favor and think of these little magical pennies here. In fact, do yourself one better and print off that image there to tape to your computer! That way every time you open up Amazon you\u2019ll be reminded how much you\u2019re really spending.\u201d<\/p><\/blockquote>\n

I love it! Every penny you save is a freedom fighter in your army. Every penny adds to the trickling stream as it builds momentum, getting bigger and bigger until it eventually becomes an unstoppable, gushing river of money. Awesome stuff.<\/p>\n

Its a fact – living within your means and investing wisely is the foundation of a strong financial house. Over the decades, compounding interest will work its magic and make you a millionaire<\/a>.<\/p>\n

But\u2026<\/h2>\n

I would argue that living below your means and investing wisely is just the price of admission to the wealth building game. It\u2019s only doing the bare minimum to harness the power of compounding in your financial life.<\/p>\n

Why You\u2019re Probably Not Harnessing The Full Power Of Compounding<\/h2>\n

As J Money explains<\/a>, you can apply the magical doubling penny to your life by:<\/p>\n

\u201cINVESTING your money Right. Now.
\nLetting it ride for years and years and years and years (perhaps 31 of them? :))\u201d<\/p><\/blockquote>\n

Investing early<\/a> and letting it ride for 31 years will certainly do wonders for your portfolio, but I believe it\u2019s only just scratching the surface of what compounding can do for your financial life.<\/p>\n

Let\u2019s revisit the ol\u2019 doubling penny chart, but now let\u2019s imagine it as a working life of 31 years:<\/p>\n

\"magical-doubling-penny-worklife\"<\/p>\n

If we take a closer look at the parable of the magical doubling penny applied over a working life, it turns out the doubling penny only turns into significant money in the last 10 years. It only breaks $1 million in the last 4 years.<\/p>\n

This tells us that compound interest isn\u2019t that powerful unless we either:<\/p>\n

    \n
  1. Start with a significant sum of money<\/li>\n
  2. Wait for a long, long, LONG time to pass<\/li>\n<\/ol>\n

    It\u2019d certainly be nice to retire a multi-millionaire after 31 years, but if you already have your spending under control<\/a> and you\u2019re investing regularly<\/a>, why just stop there?<\/p>\n

    What if there was a way to apply the magical doubling penny to build your own millions, WITHOUT waiting around for 30 years?<\/p>\n

    I would argue that there IS another way to apply the doubling penny phenomenon to real life, one that is significantly more powerful than just waiting for time to compound your savings over the decades.<\/p>\n

    The Compound Interest Formula<\/h2>\n

    Before we reveal this powerful force, let\u2019s revisit the basic compound interest formula:<\/p>\n

    \"compound
    \nI can\u2019t help but notice that there are a lot of variables here we can\u2019t control:<\/p>\n