The Most Powerful Tool in Wealth Creation
Updated: Jan 18, 2021
In his book The Fourth Age, Byron Reese illustrates the story of the invention of chess.
“About a thousand years ago, a mathematician in what is today India is said to have brought his creation to the ruler, and showed him how the game is played. The ruler, quite impressed, asked the mathematician what he wanted for a reward. The mathematician responded that he was a humble man and his needs were few. He simply asked that a single grain of rice be placed on the first square of the chessboard. Then two on the second, four on the third, each square doubling along the way. All he wanted was the rice that would be on the sixty-fourth square.
So how much rice do you think this is? Given my setup to the story, you know it will be a big number. But just imagine what that much rice would look like. Would it fill a silo? A warehouse? It is actually more rice than has been cultivated in the entire history of humanity’’
At the end of his 64 squares to put it into numbers, the mathematician would have had 18,446,744,073,710,149,632 grains of rice.
Chances are that you have heard some variation on this story time and again throughout your lifetime. The end result of compounding is extremely appealing to us, and yet very few people are naturally taking advantage of it when it comes to their money.
Compounding your money works in much the same way that it worked for the mathematician in Reese’s story. The longer you stay invested in the market, the more of your gain will disproportionately come from your early gains rather than your capital. However, you might need to see where those numbers are really coming from.
Let’s take a look at a theoretical example. In our scenario, you are going to begin with a $10,000 starting balance and will make no other contributions. Assuming that you earn a 10 percent per year (linear return), you would have a balance of roughly $25,900 in ten years. Just under 40 percent of that money came from your own contributions. The rest was accrued through interest on your initial balance.
How would the balance look in thirty years? Well, you would have roughly $174,000 in your account. Now, your initial balance makes up just six percent of the total portfolio amount – a shocking statistic! You did virtually no work at all after investing your first $10,000 and the compounded interest has given you great returns. The real star of the show is the compounding which served to accelerate your gains throughout the years.
The truth of the matter is really quite simple: nothing is more powerful than compounded returns over a long period of time. A market return will never be strictly linear, so our example might not be exactly how your own investments turn out. Not to mention, different people will have different needs based on their time horizon and risk tolerance. However, the truth is still the same across the board. It is best to invest what you can now to take advantage of those compounding returns moving forward.
What Should You Do?
You might already know that compounding is the way to go if you want to earn the most on your investments, but what should you do in the here and now? Many people spend hours and hours trying to predict where the market is headed. However, there are better ways to spend your precious time and yield much better results on your investments.
The best advice that any financial planner can give you is to start today. The sooner you are able to begin saving, the more time you will have on your side for your money to work harder on your behalf. As you saw in our example, even a small initial investment can pay off majorly when it is left to compound the interest over the long haul.
No matter what your needs are or what goals you have, you should be taking the long view for your investments. Plan to spend years in the market instead of trying to cash out quickly. Most people have learned the hard way that it is nearly impossible to time the market. Instead, plan on spending time in the market if you want to make your fortune.
By starting today and letting your money work hard while you sit back, you can become just as rich as the mathematician who invented chess. Take the long view and start today to be as successful as possible.