The Magic of Compounding

🤝 Hi Digital Travelers,

Welcome back to Adulting!

I still can’t believe that throughout our entire adult lives the only way we can learn finance is through a university or third-party teacher.

It’s not like it’s more important than social studies.

Thanks, modern education system!

With that, today, we are going to unravel the magic that is the compounding of money, a concept that's crucial because it's essentially about making your money work for you. (and because for some reason I have trouble grasping this concept even with my STEM background).

It's the closest thing to a financial magic spell, and understanding it is a big step towards financial maturity.

So, grab a cup of coffee (or your preferred potion of choice), and let’s dive into the mystical world of financial growth.

👾 Adulting Lesson

In the realm of finance, the concept of compounding is often hailed as the eighth wonder of the world.

It's the process where the value of an investment increases because the earnings on an investment, both capital and earned interest, earn interest as time passes.

Simple.

Except financial jargon sucks.

Compounding is similar to erosion. (I know, THATS simpler than financial jargon (you say in a sarcastic tone). But hear me out).

Compare compounding to how the Grand Canyon was formed.

A small bit of water eroded some rocks away.

Then more water could flow.

Then more rocks got eroded.

Then even more water could flow.

Then EVEN more rocks got eroded.

Iterate and boom.

Grand Canyon.

Same thing as compounding.

Lesson 1: Understanding the Basics of Compounding

Compounding is the process where you earn interest on both your original money and on the interest that money has already earned.

For example, if you invest $1,000 at an interest rate of 5% per annum, after the first year, you'll have $1,050. But compounding means that in the second year, you earn interest not just on your initial $1,000, but also on the $50 interest from the first year, making your total $1,102.50 at the end of year two.

The magic continues year after year, with each sum growing larger as time marches on.

The same as water erodes rocks.

Lesson 2: The Rule of 72

A quick, handy tool to grasp the potential of compounding is the Rule of 72.

This rule gives you a rough estimate of how many years it will take for your investment to double at a given annual rate of return.

You simply divide 72 by the annual rate of return to get the number of years.

For instance, with an annual rate of return of 6%, it would take roughly 12 years for your investment to double (72 ÷ 6 = 12).

This rule showcases the allure and the power of compounding in a nutshell.

Remember, investing isn’t a get-rich-quick scheme (thanks crypto). It is tactical and patient.

Lesson 3: The Importance of Starting Early

The earlier you start investing, the more time your money has to grow through compounding.

A person who starts investing a small amount at age 25 could accumulate more wealth by age 65 than someone who invests a larger amount but starts at age 35.

This emphasizes the adage: It's not timing the market, but time in the market that counts.

The more time your money has to compound, the larger your wealth snowball can grow.

I know it’s cliche to say this, but just start investing a little every month. Literally do S&P 500 index ETFs and you’re done.

Conclusion

The lessons shared today are more than just financial theories; they are life-changing truths that can set you on a path of financial growth and freedom.

It's like having a golden goose, but only if you nurture it early and wisely.

With every interest earned and reinvested, you're not just saving; you're creating a legacy of financial stability.

Together, we'll not just survive but thrive in this journey. (and I got to understand compounding)

📝 Actionable Advice

1. Understanding the Basics of Compounding: Start with what you have. No amount is too small to invest. Look for savings or investment accounts with a decent interest rate, and let the magic of compounding commence.

2. The Rule of 72: Use the Rule of 72 to set realistic expectations for your investments. It's a simple yet powerful tool to visualize how your money can grow over time.

3. The Importance of Starting Early: Time is of the essence. Begin your investment journey today, no matter your age. The earlier you start, the bigger your financial snowball will be.

🎙️ Quote of the Week

✌️Closing Time

And with that, we draw the curtains on this edition of Adulting.

As we part ways, remember, the road to mastering adulting is dotted with cents and dollars that can grow into a treasure trove.

So, let’s keep rolling our pennies down the hill of compounding, and watch as they multiply into a rolling fortune.

Until next time.

Cheers,

Mike