An interesting study found that when given the option of receiving a million dollars now or getting a single penny and having its amount double every day, 90 percent of individuals chose to receive a million dollars immediately.
At face value, the decision to take a million dollars immediately might seem obvious. After all, a penny seems absurdly smaller, even when doubling in value daily. However, a closer look at the data reveals that those who choose a million dollars short changed themselves by nearly 10 million dollars at the end of thirty days, thanks to the phenomenon of compound interest.
This example just goes goes to show the power of compound interest, and why it is so misunderstood by the general public. With that in mind, here are some focal points to help you understand and successfully use compounding:
So what is compound interest, and why is it so powerful?
Compound interest can essentially be thought of as “interest on interest.” In investing, it means that the returns on your investments are added onto the principal (the initial amount you invested) – so your balance doesn’t merely grow, it grows at an increased rate over time. Hypothetically, the penny example shows what would happen if your initial penny doubled in value through investing, and then those returns were added onto the principle to grow even more.
Although it’s highly unlikely you’ll find an investment that doubles in value every single day, the power of compounding can still be immensely valuable when it comes to long-term investing too.
How can you harness the power of compounding?
Investing as soon as reasonably possible gives you one advantage money can’t buy: time. Just like in the penny example, a small investment made now can become exponentially larger after having ample time to grow and compound. By sticking to a long-term investment strategy, you can reap the power of compounding for years or even decades.
Prudent investors make plans to invest as soon as reasonably possible because of compounding, even if they have only small amounts available now. That way, they don’t have to play retirement catch-up or miss out on opportunities for their wealth to grow.
Learn more about the power of compounding
At LexION Capital, we help our clients harness the power of compounding through bespoke, long-term investment solutions. If you’d like to learn more about how we can help you utilize compound interest to achieve your financial goals, we’re happy to start a conversation today.
