From Tom Dyson, publisher, the Palm Beach Research Group:
The most powerful force in finance is the law of uninterrupted compounding.
Compounding is a simple investment strategy in which you put your money in an investment that pays interest. At the end of the year, you take the interest you earned and reinvest it with your original stake. Now your interest earns a return as well. The next year, you’ll get a bigger interest payment. Then you reinvest that payment, and so on…
A snowball is the best analogy for compounding. As you roll the ball through the snow, the surface area gets bigger. The more surface area on the snowball, the more snow it picks up. The snowball gains mass slowly at first… but pretty soon you can’t move it because it’s so huge.
Compounding is slow and boring at first. But gradually, the interest you earn grows and your reinvestments increase. And the longer you allow your money to compound uninterrupted, the more it grows.
The key to compounding is to let it work over many years. The chart below shows the value of an account when we grow it at 10% per year over 60 years. We call this the “hockey stick” chart, because the money grows slowly for several decades and then really picks up speed after about 40 years.
The Hockey Stick
If you don’t interrupt it, compounding produces a fortune.
At 10% interest, it takes 40 years for $10,000 to grow into $411,000.
That’s pretty good. But do you see what happens next? The growth of the account explodes.
By year 50, it’s grown to just over $1 million.
By year 60, it’s grown to more than $3 million.
In short, the power of compounding is most effective when you let it work over many decades.
Interrupting the Compounding Process
The compounding process works only if you don’t interrupt it… i.e., you don’t pull money out of the account along the way.
The chart below shows what happens if you make an early withdrawal and pull $150,000 out of your account in year 40.
As you can see, first, the balance in your account drops. That’s the red line you see dipping below the black line. Second, there’s less money in the account to produce interest. You’ve interrupted the compounding.
Look what it does to your wealth…
In year 50, you’ve got $713,000, instead of $1 million. And by year 60, you’re left with $2 million, instead of $3 million. Your account balance is $1 million less in year 60.
One small withdrawal causes your wealth to plummet.
Thirty-, 40-, and 50-year periods are long. They’re hard for most people to fathom. But we use these time frames to illustrate one important point.
Interrupting the compounding process by liquidating part or all of your funds is the single biggest destroyer of wealth.
These interruptions are not always easy to spot. For example, a decline of 20% in the stock market interrupts the compounding process in your 401(k) account. That’s because your account balance dropped by 20%. And you have less money producing interest.
You could cash out part of your 401(k) or IRA to buy a new car or house or to give a gift. That interrupts compounding as well.
Or consider your child’s college fund. You start putting money into it when your child is born. It compounds and grows tax-free in a Coverdell or 529 Plan.
But when your child reaches college age, you liquidate the account to pay for tuition expenses. You’ve interrupted the compounding process after only 18 years.
The Holy Grail of Finance
You know leaving your money alone and letting it compound produces great wealth. But there’s one downside to this: You can’t touch or access your money for a long time. That’s because you’ll interrupt the compounding.
The holy grail of finance is a vehicle or account that relentlessly compounds your money. But at the same time, it lets you access your money without interrupting the compounding process.
Does such an account exist?
Dividend-paying whole life insurance—the kind we use with Income for Life—offers us these exact benefits. We put money in one of these policies, and it compounds for the rest of our lives. We capture the power of uninterrupted compounding, and we get rich.
Regular Daily readers know Income for Life policyholders use “policy loans” to access their funds while they continue to compound, uninterrupted. But they may not know that this form of “private banking” is also tax-advantaged… not reportable to the IRS… and 100% legal. To learn how to harness the full power of the “Holy Grail of Finance”.