A Penny Saved is A Dollar Earned

You know the old adage, a penny saved is a penny earning. I think you can do a lot better than that. Without any real effort, that penny can grow to become a dollar. Now imagine doing that with thousands of dollars. Anyone can do this.

There is not a get-rich-quick scheme. There’s nothing nefarious or immoral here. This is completely above board. The biggest factors involved in turning your pennies into dollars are time and compounding.

The compounding principal is such an important concept; I have long advocated that it should be a required course in Middle School or High School. If you were fortunate enough, you learned about this in when you were growing up in school. Unfortunately however, money management is not part of the curriculum in most schools. If you already understand about the “magic” of compounding, consider yourself quite fortunate.

When you were young, someone may have said to you: “I can give you $10,000 each day for 30 days or I can give you a penny today and double the amount that you receive every day for 30 days.” Which would you choose? Most people would jump at the $10,000 a day, right? Quick arithmetic tells us that we could have $300,000 at the end of the month. There’s no way that doubling a penny every day for a month could possibly add up to $300,000. You’re starting with just a penny. How much could doubling that each day possibly get you? Would you believe more than $5 million! Actually, doubling a penny every day for 30 days comes to $5,368,709.12 to be exact. While you will almost certainly never see your investments doubling every day, this concept dramatically illustrates the magic of compounding.

The money you save – whether you put the money into a savings account, a mutual fund, or into individual stocks – will earn interest over time. As time goes by, you earn interest on the money you originally saved/invested, plus the interest that you’ve accumulated earns interest itself. As your savings grow, you earn interest on a bigger and bigger pool of money.

For example, the following chart shows the impact of a $1,000 investment, compounded at various rates of return over time:

compound investing

While these returns pale in comparison to the $5 million that you could get in the hypothetical example above, you can see how much your money will grow in a real life example. Let’s say your grandparents gave you $1,000 as a graduation gift. Instead of spending it on a new phone, and taking your friends out for drinks, you invest that money. If you never add another penny to that account, your $1,000 investment, earning 10 percent every year, will be worth over $45,000 after 40 years. That’s only your original investment, plus the interest it earns year-after-year compounding as well; without any additional savings added to the account. A $1,000 investment “magically” compounds to more than $45,000 after 40 years without any actions on your part or any additional investments.

“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it,” said Albert Einstein. Think of a snowball. It’s small. It fits in your hand. Now think about what happens when you roll that palm-sized snowball downhill. The snowball picks up more snow and continues to get larger and larger. We saw that a $1,000 investment can grow to over $45,000 purely through compounding. Now let’s see what happens when you add an extra $1,000 to your investment every year.

compound investing magic

A $1,000 investment every year, earning 10 percent annually, will result in more than $532,000 after forty years. Think about that, your total investment would have been just $40,000 ($1,000 a year for 40 years), and assuming your money had grown at 10 percent annually, it will have “snowballed” into more than half-a-million dollars. That’s the magic of compounding! The earlier you start investing, the more your money will grow.

Okay, so it’s not pennies into dollars per se, but investing just $1,000 every year – that’s about $2.73 a day, probably less than you spend each day on a cup of coffee – you could probably end up with somewhere between $300,000 and $500,000 after 40 years.

The longer time horizon you have, the more money you can have. You are likely familiar with Warren Buffett; arguably the best investor there ever has been. Mr. Buffett is the 2nd richest man in the USA, behind Bill Gates. According to Forbes, Warren Buffett’s net worth in 2015 was over $62 billion. What might come as a surprise to you is that the 85-year old multi-billionaire made 99% of his fortune after his 50th birthday.

image courtesy: vintagevalueinvesting.com

image courtesy: vintagevalueinvesting.com

It’s About Time in the Market, Not Market Timing

That chart is an incredible illustration of the magic of compounding. I indicated that you could expect to have about $500,000 after 40 years. So if you start investing $1,000 a year when you turn 21, you could have half-a-million dollars by about your 60th birthday. Ten years later, that number could increase to nearly $1.4 million. Are you getting the idea that pennies can indeed turn into dollars?

Save you pennies. Invest early. Invest as much as you can. Continue investing. You will build wealth and you might eventually become a millionaire.

 

 

One Response

  1. Aime Matunda Pero April 12, 2017

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