The Mysterious Mojo of Compounding Interest

It’s no secret that there is a type of magic in Compounding Interest.

This is the reason I plan to decipher compounding interest, so that smarter decisions can be made financially.

 compounding-interest

Everyone knows that financial planning and personal finance can get a bit boring.  On the other hand, consumerism and inheriting new debt is at an all time high.  Consumerism is sexy and sells, so lenders and savvy retailers know this.  That’s why it seems every other commercial on tv or radio is about some sort of credit card or other means of getting you to ‘charge’ it and worry about it later.

 

Another interesting fact is that the people pushing you to get further into debt – practice the law of producing.  They fulfil a market need getting consumers deeper into debt just to see those same people see an absolute snowball against their finances plummet.  This is what keeps unsophisticated consumers in debt for years to come and on the proverbial and financial ‘sinking ship’.

 

While it’s true that personal finance is not glamorous, most people live pay check to pay check as opposed to an abundant life they’d rather live.  They have a consumer and ‘me too’ mindset as opposed to a Millionaire Mindset.

 

Ok, so first off, let me introduce you to how you can seriously become the ‘lion’ that catapults your finances rather than ruin your financial destiny.

 

Just What is Compound Interest?

 

According to bing.com, compound interest can be defined as:

 interest on borrowing and accrued interest: interest that is calculated on the combined total of the original sum borrowed principal and the interest it has already accrued

 

Now, that we have a good grasp on just what compound interest is, let’s see how we can integrate it financially to give us awesome returns.

  

An Awesome Example of the Mojo of Compounding Interest

To give a really great lesson of just how powerful compounding interest is, let’s look at an awesome example of just what mojo Compound Interest possesses. 

 

How about a virtual game of Ping Pong?

In the case, you don’t know how to play ping pong, here’s a crash course in the game so that you are at least on the same page as me.

 

Ping pong consists of two players playing on a ping pong table with a pong ball hitting the ball over the net to the opponents side.  Without getting into the technicalities, let’s concentrate on the scoring aspect of ping pong.  The winner in a ping pong game is the first player to reach 11 (eleven) points and plays a certain amount games.

 

Let’s say that I play a virtual Ping Pong game against you and because we are both friends we decide to make it interesting by putting a wager on it – Savvy??  We decide on the best of 3 games is the winner (this results in 2 games won by the winner – best of 3 games).

 

So, for our virtual game of ping pong we decide to play one game of ping pong and the first one to win 11 points is the winner and you must win 2 of the 3 games.  Now, remember our wager from above?  Good, so we decide the 1st point will be worth 25 cents and ever point after that we will double the wager (so, the second point would 25 x 2 = 50 cents e.t.c. till we reach 11 points and then repeats for game #2). 

 

This is where the excitement really comes in as we’re going to see compounding interest in action. 

 

Let’s now say we just started our virtual ping pong game and have just finished (doesn’t matter who won as it’s for illustration), now here’s how our wager system would look like with the 1st point worth 25 cents and doubling that money every point:

 

Game #1 – Ping Pong Wager example

Point 1 = 25 cents

Point 2 = 50 cents

Point 3 = $1.00

Point 4 = $2.00

Point 5 = $4.00

Point 6 = $8.00

Point 7 = $16.00

Point 8 = $32.00

Point 9 = $64.00

Point 10 = $128.00

Point 11 = $ 256.00

 

Game #2 – Ping Pong Wager example

Point 1 = $ 512.00 ($256 x 2 from game 1 above)

Point 2 = $ 1,024.00

Point 3 = $ 2,048.00

Point 4 = $ 4,096.00

Point 5 = $ 8,192.00

Point 6 = $ 16,384.00

Point 7 = $ 32,768.00

Point 8 = $ 65,536.00

Point 9 = $ 131,072.00

Point 10 = $ 262,144.00

Point 11 = $ 524,288.00

 

Wow, can you see that the total of each point, originally worth 25 cents and then doubling each point, could end up making one of us $524,288.00 !!  This is the power of compounding my friend. 

 

At the beginning, compounding kind of just gets going, but when the numbers start getting larger – watch out!  This is the kind of system you need working for your money day and night.

 

A Real World Example of Compounding in Action

Here’s some more food for thought, let’s say that you can save a paltry amount of just $200 per month for our compounding interest example.  That’s $2,400.00 a year invested and let’s also say that we have an investment that can yield us 15% interest per annum on average.  Now, if we invested this money for say 30 years, we would have 1,213,138.96!

 

Yes, more than a million dollars for an investment of $200 a month over 30 years.  Some people spend more than that on booze or cigarettes in a given month, so why not find that money and get it working for you instead?  See financial illustration A.

compound-interest-2

Illustration A.

 

Now, that was just an example, what if you could invest even more than that $200, let’s say for our purpose $300 a month?  You get the picture and I endorse that you play around with this free compound interest calculator found at Money Chimp.

 

So, now that you see the mysterious power of compounding interest, go forth and make your financial dreams set themselves in motion!

 

If you enjoyed this post, please make sure to share it on social media such as FaceBook or Twitter – it’s good karma.

 

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Category: Financial Investing, Financially Elite Blog

  • Lisa O

    Thank you! Such a thorough and easy to understand explanation of compound interest! If only I had this back when I took personal finance!