Snowball is not the name of a cocktail.
Could you remember any of the wonders of the world? if not, do not worry, here well served for you:
- Colossus of Rhodes
- Great Pyramid of Giza
- Hanging Gardens of Babylon
- Lighthouse of Alexandria
- Mausoleum of Halicarnassus
- Statue of Zeus at Olympia
- Temple of Artemis at Ephesus
- Compounding
Did you spot anything odd? I know you did. The 8th in the list is something special. The 8th is yours only. And only you can decide to enjoy it or ignore it.
If you decide not to enjoy it, you should rethink twice, maybe more.
Wondered how that $166,300 in "Do you believe 33 years is plenty of time to become Wealthy?" turned into $832,130 in 33 years without touching a finger?
That is why the 8th wonder exists. It transforms time into money!
Let’s give the 8th wonder a proper name: Compounding.
Compounding means that as time goes by, the growth that you generate by investing your capital, will generate further growth on top of it. And this is awesome.
You will master this concept with a real life case.
Your friend Jack needs $5. You love Jack, so you lend him the money. Jack is happy and asks you if he could return the money back in 1 year.
You are happy with his request but you want 4% interest on it. Jack accepts, he is happy. You are happy as well.
In one year time Jack will give you $5 plus 20 cents ($5 x 4%). The 20 cents come from the 4% interest rate that you charged Jack for the favour rendered.
Suppose that as soon as Jack gives you back $5.20 (one year from today), your friend Simon asks you to lend him $5.20 for one year. You say OK, and in a similar fashion, you ask Simon 4% interest on the money that you lend him.
OK understood you got it... at the end of the second year (2 years from today) Simon will give you back the $5.20 plus $0.208 cents ($5.20 x 4%) for a total of $5.408.
So to sum up, besides maintaining friendship with Jack and Simon, you have made a nice return on the investment (yes, you can call "lending money to your friends" an investment).
Do you know how much return on the investment you have made? More or less than 4%? Think about it. If you are tempted to say less than 4%, fair enough, but it is wrong.
If you say exactly 4% ... mmmh still wrong.
Ok, more than 4%! Correct. But how much more?
More than double! Hold on you might think, how is it possible?
Yes, you have made 8.16% return over 2 years.
Let’s decompose this 8.16% return.
4% during the first year + 4.16% during the second year.
But how can it be possible that you have made 4.16% on the second year when you have lend money to Simon at 4%?!
This is the magic of compounding. Keep this secret and enjoy what comes out of it.
The extra 0.16% (4.16% - 4%) that you generated during the second year on top of what you would have expected (4%) is the gift of compounding.
There is more. Hold on. The longer you keep investing, the bigger this gift becomes.
You will discover more of this wonder in further teachings.
Enjoy it.
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