A miracle generally involves something that cannot be explained by science, or perhaps even the supernatural. Compound interest might not fit that definition of a miracle, but it’s damn close.
How else can you explain that $ 1 invested in the Dow Jones Industrial Average when it was launched will become roughly $ 150,000 by 2021? Yes, that’s over 125 years, but it’s still strong growth – around 10% a year on an annual basis. The answer is not divine intervention. It’s just math.
Many people have heard the story of the grain of rice and the chess board. In return for 64 days of work or the like, a peasant demanded a single grain of rice from a king on the first day and double wages every day. By the 64th day, the king owed the farmer about 300 million tons of rice. That’s exponential math, and it’s behind the power of compounding.
Investors cannot double their money every day. (Learning to turn down deals that promise such a return is another lesson in investing.) Money grows slower than rice wages in the fable.
This is how compounding works: The initial $ 1 has little to do with 150,000 times the profit. Most of the profit comes from all of the reinvested interest that money earned can make money. It’s amazing, and the safest way to get rich quick is to invest in the market and wait – well, for years.
So maybe it’s not going that fast. But the power of compounding shows why it is so important to stay in the market for a long time, through thick and thin. Successful investors don’t try to time the market. They are trying to maximize the time in the market.
We’ll talk more about how to make money in this video. But first answer the following:
What interest do you need to earn to double your money in five years?
For the answer and much more: Clock.