Would you be better off if someone gave you $1 million today, or one penny that doubled every day for 30 days?
You’d be much richer with the penny.
In fact, the difference between the two choices is staggering. After doubling every day, 1 cent on Day 1 turns into over $5 million by Day 30.
Sound hard to believe? Take a look…
It’s all about the power of compound interest – something we write about often. Albert Einstein called it the eighth wonder of the world. Warren Buffett says it’s one reason he was able to amass such a huge fortune.
At Palm Beach Research Group, our mission is to make more millionaires over the next 12 months than any other financial newsletter. And compounding is one of the best ways to build wealth…
Infinite Wealth-Building
The key to compounding is to let it work over many years.
Just look at the chart below… It shows the value of an account growing at 10% per year over 60 years.
We call this the “hockey stick” chart because the money grows slowly for several decades then really picks up speed after about 40 years.
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 (see the red arrow).
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.
Don’t Interrupt the Process
The compounding process works only if you don’t interrupt it… In other words, if you don’t pull money out of the account along the way.
Let’s say you make an early withdrawal and pull $150,000 out of your account in year 40.
As you can imagine, first, the balance in your account drops. 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 aren’t always easy to spot.
For example, a 20% decline 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.
Or 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 account 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.
Remember, if you don’t interrupt it, compounding produces a fortune. It’s a simple process… but not easy to pull off long term.
But if you have the discipline to allow your money to compound, you’ll eventually build long-term sustainable wealth.
Palm Beach Research Group