by Jet Villamor
Albert Einstein once commented, “One of the greatest mathematical discoveries of all time is the concept of COMPOUNDING.” There may be some violent reactions coming from all the other branches of mathematics on this claim, but there may be some truth to it because this concept when maximized will practically make each one of us really, really wealthy – unlike trigonometry which we hated way back in high school — the compounding concept makes it possible for our money to snowball. Compounding gives beauty to, and is the crowning jewel of, investing.
I find this concept really worth sharing for us to be able to realize how valuable this idea is. But of course – compounding is a team player, it works with time. Compounding without time is worth nothing as a concept.
I was once asked by a friend who was way ahead of me in terms of making investments – his question was more of a test for me as to how far I had gone in terms of understanding the basic concepts of investing, his question was – (let me also pose this question to you now): Suppose you are offered a job that will only last for thirty-one (31) days and you are made to choose as to the mode of salary that you’d like to have when the job is done, what would you choose? A. a flat P1,474,836.47 that you’d receive after thirty one days or B. One centavo on the first day, doubled the next day (double whatever you received the day before) and doubled everyday until the thirty first (31st) day?
Is your answer letter A? – Definitely its very tempting, who would not be tempted to accept P1.47M for 31 days work? If your choice was A, and assuming the exercise is a real situation, like the “pera o bayong” game. You should have regretted your decision big time because if you answered A, you would have thrown away P20,000,000 right there. Yes P20M. How is this possible? Let me show you a very simple illustration.
It’s really amazing. Indeed compounding is a very powerful tool. You are no longer doubling centavos starting on the 8th day, by the 15th day you are already doubling hundreds, on the 18th day you’re doubling thousands and by the 28th day you are already doubling by the millions. The amazing magic of compounding is simply like it is,- making 100% of your money everyday if we are to use our illustration.
As I’ve mentioned earlier, compounding is a team player and it works with time and the rate of return. The longer the time that you’ll compound your money, the bigger will be the outcome. But it will be a lot more if we have a longer time, higher rate of returns and bigger sums of money playing together as one – this is the most ideal of all the investment situations.
But the reality is, many today do not have the money even if they have the time, those who have the money may not also have enough time, those who may have the time, and who may have the money may not also know where the higher rates of returns are and that is why they just simply park their money in time deposits making their money under-perform.
An interest earning money grows at a steady rate, but when the interest earned by the original amount is added to the principal – more money will be earning interest and when there are more money earning interest it will dramatically snowball the value like no other in no time.
(for questions, comments, suggestions and reactions email @ jvvillamor@insular.com.ph)
