I often find myself thinking back to my high school days and feeling a bit sorry for those kids who elected not to do maths as a subject. These are the people to whom it’s very hard to explain concepts such as compounded interest and the magic behind what is essentially the best instrument one can use to steadily grow money which they otherwise don’t plan to touch for a long time to come. We all know that merely putting money in the bank via something like a savings account is nothing short of shooting yourself in the foot, quite simply because the interest you earn on money stored in this way falls far behind inflation and, together with the banking fees you’ll be subjected to, it ultimately works exactly the same as spending some of that money each month.
That’s why there’s some magic to compounded interest, but naturally the magic only works if you are indeed planning to leave that money in the bank for a considerable amount of time to come. For this compounded interest magic to work, you’d have to leave your money in the bank without touching it, otherwise the exponential formula used to work out the compounding interest you earn basically resets to your starting point.
I simply cannot emphasise this enough – if you have some money lying around which you don’t know what to do with, talk to your bank about the options you have for a savings pocket which offers compounded interest. As insiders working in the financial industry, we’re often prohibited from engaging in investments which allow us to profit from what is deemed to be an unfair advantage over regular consumers, but I think they missed one investment avenue in compiling the list of what is prohibited. We’re fully allowed to take advantage of compounding interest and that’s exactly what I’ve chosen to do myself.
The terms (and the exponential formula) used naturally differ from bank to bank, but basically if you understand the basic principles of an exponent, you’d be crazy not to want to take advantage of compounding interest. Basically if you just look at an exponent in its simplest form, you’ll realise that at some point along the way, each monthly (or annual) iteration of the formula means that your money grows at an ever increasing rate.
Think of it as a dam into which you decide to throw a certain volume of water. Based on this initial amount of water you’ve decided to pour into the dam, for as long as you don’t draw any water, someone comes with a little bit more water to pour into that dam. Each time they come with more water, the amount increases incrementally, with the new amount to be added calculated according to the amount of water currently in the dam and not the amount of water you originally poured in when you started out.
Essentially, an exponent grows infinitely as it gets closer and closer to infinity, but infinity is well infinite, so basically your money grows forever by an ever growing percentage each time, until you decide it’s time to draw on it of course.
The best living example of the power and magic of compounded interest is its very widely touted ability to double your initially invested money in no more than a period of seven years. Judging by how quickly time tends to fly that’s not a long time at all to double your money and there’s perhaps no other way of achieving the same effect with the limited risk associated with compounded interested.