A certainty: the power of compounding and time

Which of these two options would you pick?

  1. $737,000 today, or
  2. One cent today that doubles in value every day for the next 30 days

There is no right answer. But if you picked #1, you would have missed out on $10 million:

That’s the power of compounding. The daily percentage return for all 30 days is a constant 100% (value doubles every day).

Unfortunately, the example above is impossible. Sorry. In reality, a 100% daily return (~36,500% yearly return) doesn’t happen. To illustrate a more realistic example, let’s look at the hypothetical scenario of Early Earl, Average Avery and Late Larry.

Earl, Avery and Larry invested the same amount for the same time period - $12,000 per year for 10 years. All three earned 6% per year. The only difference across the three of them is the starting point: Earl invested from 25 to 35 years old; Avery invested from 35 to 45 years old; and Larry invested from 45 to 55.

By the time they reached 65, Earl had nearly $1 million versus Avery’s $538,000 and Larry’s $300,000. In other words, Earl ended with almost double Avery’s money and more than triple Larry’s money. He took advantage of one of the few certainties in investing: the power of compounding and time.

As humans, it is difficult for us to grasp the power of compounding because we tend to think linearly instead of exponentially. If we break free of linear thinking, it opens us up to new potential. Every time we decide whether to spend or save, invest now or later, we should remember early Earl and the iron law of compounding.

P.S. Compounding can go the other way too. If you carry credit card debt, compounding is working against you. At 15% interest, maintaining a balance of $10,000 in credit card debt will turn into $11,500 in debt after one year. As Albert Einstein said: “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.” The subject of debt will be discussed further in a future commentary.

Examples are hypothetical and for illustrative purposes only; not indicative of the actual performance of any particular financial product. Results are not guaranteed and do not include any product fees, expenses, or taxes. Compounding is a hypothetical mathematical calculation with no assurance that any investment will double within a specific time frame.

The information provided is general, educational and not intended as an offering of any specific products or services, nor considered as specific investment, legal or tax advice. Individual situations can vary, and an individual assessment to your specific situation should be used.