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Friday, July 20, 2012

What hell will break loose by the "Amazing Power of Compounding"

"Time is the most powerful element". No other mathematical formula proves it better than the formula to calculate the Compound interest.

Each one of us have studied "Simple Interest" and "Compound Interest" as a part of our mathematics education in our primary schools. Most of you understood the formula, though there must have been  many like me, who mugged them up. We also might have also scored 100% marks in the questions related to these topics. We also knew (and still remember) that Simple interest was about getting interest on the principal amount while Compound Interest talks about giving interest on the Principal as well as the interest.

Fundamentally, that is it about Compound Interest. It is so simple. So, what am i trying to prove with this article.? I am trying to shake you up and trying to help you realize the immense power that lies behind the simplicity of these definitions and formulae.

Most of us think that what big difference does it make. I mean, if i am earning a meagre interest on the Principal (via Simple Interest), what hell will break lose if i earn a fraction more interest on the interest (Compounded Interest). I mean, it does not have any major impact on my life...may be i can afford one extra ice cream with that. Though anything "extra" is welcome in life, well, most of the times it may not be worth paying that extra effort. It is just "some extra money".

That is exactly where we all missed the point. That is where all the hell broke loose. That is where the "Time" played its magic and we were not even aware of the same.. Let me ask you a very simple question. I give you a normal sheet of paper (lest say roughly 0.1mm thick)paper and ask you to fold the paper once. Now, i ask you fold it once again all over. Remember, it is becoming thicker as you are folding. OK, hold on, before you lose patience, just try and judge the thickness of this sheet if you were able to successfully fold it just 50 times. Well, let me tell you.... the paper will become so thick that the thickness would cover the distance from the earth to the moon. Cant believe it? I also did not believe it in the beginning but you can do the calculation..it is very simple to calculate. It is the power of compounding - remember - you did not take out any of the thickness when doubling the next fold (that is earning interest on interest)... and do you want to know what "Time" did. If you did just one more fold - just one more - you new thickness can take you back to earth as well. What you achieved in the first 50 folds was achieved in the last "1" fold.

Is the hell breaking lose now? It really breaks lose if you let the same concept apply on your money.

You have literally no idea what magic can happen to your wealth if you allow time and power of compounding to work together in an undisturbed manner (don't touch your money or its interest while it is compounding to realize its amazing power)

So, we all studied the definitions of simple and compound interest, mastered it but never realized the potential it has when applied to your own money. It is the single most important cog in the wheel if you are looking to achieve Financial Freedom in life. Just one extra year of compounding can separate a millionaire from a billionaire. It is that powerful !!

As you would go through my book (From Rat Race to Financial Freedom), you would find various ways to utilize the power of compounding to your advantage on your journey to your own personal financial freedom.

Happy Compounding !!

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