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Miracle of Power of Compounding in Wealth Creation THE POWER OF COMPOUNDING IS THE MOST POWERFUL FORCE IN THE WORLD THE POWER OF COMPOUNDING IS THE MOST IMPORTANT OF ALL WONDERS OF THE WORLD THE BEST TIME TO INVEST IS FROM AGE ZERO, AND THE SECOND BEST TIME IS NOW. "...work like you don't need the money..." "Let money work
for you." By DILIP RAY The
Power of Compounding (POC): Affects many aspects of life: 1. Wealth
creation 2. Disease: spread & prevention 3. Population dynamics, politics, and the future of the world This book
will be on wealth creation. Copyright: 2009 by Dilip Ray. All rights reserved
No part of this publication/book/site may be printed, distributed,
reproduced, stored or transmitted by any method, photocopying or scanning except author’s permission. Disclaimer: Neither the author or the publisher
is engaged in rendering professional service or advice to any reader in this book/site. The facts, ideas, and calculations in this book/site are not intended as a substitute for consulting with
a consultant in this field. There is no advice or suggestion or recommendation
in this book/site. While the author has made every effort to provide accurate facts,
data and calculations presented at the time of publication, may not be entirely correct and suitable for many readers. Neither the author or the publisher assume any responsibility for any error or changes that occur
after the publication. The readers should seek appropriate professional advice
before making any investment decision.
Past performances are no guarantee of future performances. Neither the publisher or the author shall be responsible or liable for any loss or
damage arising from any information in this book/site.
Acknowledgement:
I greatly appreciate the efforts made by Ms. Ashley Carlyle in preparation of this book.
POWER OF COMPOUNDING (POC) & WEALTH CREATION INDEX Page Introduction 5 History 6 Definition
6 Mechanism POC & examples 7 Difference
between simple and compound interest 9 Calculation by rule of 72 11 Starting time of investment & POC starting early
vs. late? 13 Rate of Interest & POC 32 POC also Works reverse Way: Paying off Home Mortgage Early 38 Procrastination 45 College & University Endowments
48 Creating wealth for children 54 Paying
the Annual Tuition to Attend Private School vs. Saving Money by Attending Public School for Free & Investing the
Money Saved 55 Earning an Undergraduate or Postgraduate Degree 60 vs. Getting a Job and Making Investments Real life & hypothetical examples 89 Effect of dividends
on growth of Investment 143 Can POC fail? 145 Summary Conclusion 151 Miracle of Power of
Compounding in Wealth Creation Introduction POWER OF COMPOUNDING (POC) is a mathematical concept that has been around
since ancient times. Based on the concept’s potential for wealth creation, POC has been called the "most powerful force
in the world," the "8th wonder of the world," a "miracle," and the "money bible."
The first two claims have been attributed to Albert Einstein* although formal proof is lacking. Throughout history, POC has been largely overlooked as an investment tool. The reason may be that the concept is
not well-known or widely understood by the world’s population. Most likely, the oversight is due to the fact that POC,
in most circumstances, is dependent on many years of patient waiting to reap the rewards. As such, POC may be the perfect
example of the classic quote from Aesop’s fable of The Hare and the Tortoise: "Slow and steady wins the
race." POC is rarely included in school curriculums or elsewhere, thus making
the concept an unrealized, unappreciated, and underutilized mechanism of investment. History has shown that even well-educated
people and politicians who are aware of POC’s earning potential have been known not to take advantage of the concept’s
ability to generate untold wealth. POC affects aspects of life other than wealth
creation. The spread and prevention of disease and the interrelationship between population dynamics and politics are also
influenced by the concept. The financial aspect of POC will be analyzed and the practical application of the concept will
be evaluated to prove why POC is the 8th wonder of the world, a miracle, and the most powerful force in the world. Use of
repetition in the text is intentional to reinforce the importance of POC in the creation of wealth. The other two aspects
of POC will be addressed in future books. *Millard Fillmore’s Bathtub. Einstein,
compound interest: Does not compute. Comment by fact checker 07.11.06. http://timpanogos.wordpress.com/2006/07/22/einstein-compound-interest-does-not-compute/ History Most likely, the idea of compound interest evolved from the practice of lending and borrowing back
in the early 1600s. The lender would get back something more (interest or dividend) from the borrower than just the original
amount of the loan (the principal). The following two quotes are from the history section for the topic of "compound interest"
in Wikipedia, the free encyclopedia: "Richard Witt's book Arithmetical
Questions, published in 1613, was a landmark in the history of compound interest. It was wholly devoted to the subject
(previously called anatocism), whereas previous writers had usually treated compound interest briefly in just one chapter
in a mathematical textbook. Witt's book gave tables based on 10% (the then maximum rate of interest allowable on loans) and
on other rates for different purposes, such as the valuation of property leases. Witt was a London mathematical practitioner
and his book is notable for its clarity of expression, depth of insight and accuracy of calculation, with 124 worked examples." "Compound interest was once regarded as the worst kind of usury [interest], and was severely condemned
by Roman law, as well as the common law of many other countries." Source: Wikipedia,
the free encyclopedia. Compound interest (History) http://en.wikipedia.org/wiki/Compound_interest Definitions An investment is made to get a return on the investment. The return
may be interest, a dividend, or something else, such as bartering. There are two kinds of interest: simple and compound. Simple interest is interest that is calculated on
the initial investment (principal) only and not on any interest previously earned. For example, a $1,000.00 investment that
earns 10% simple interest (i.e., $100.00) each year for 8 years will continue to earn $100.00 each year. There is no compounding.
See Table 2 below. Compound interest is interest that is calculated on the original principal and on all previously earned interest. Because the
interest earned each period becomes part of the interest-bearing balance, the principal base keeps increasing. Think of compound
interest as being "interest earned on interest." The compounding frequency may be continuous, daily, weekly, bi-weekly, semi-monthly,
monthly, quarterly, semi-annually, or annually. Compound interest is also referred
to as Annual Equivalent Rate, Effective Annual Rate, Annual Percentage Rate, and Effective Interest Rate, among other terms. Source: Compound Interest, From Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Compound_interest In contrast to simple interest, a $1,000.00 investment that earns 10% interest, compounded annually,
for 8 years will earn $100.00 in interest after the first year, $110.00 in interest after the second year, $121.00 in interest
after the third year and so on through the life of the investment. See Tables 1 and 2 below. If enough time is given for POC
to work, the growth of the investment can be exponential. Exponential
growth occurs when an investment regularly increases by the same percentage.
The investment will continue to grow year after year as the compound interest accumulates. Eventually, the compound interest
will exceed every year and then every month, every week, every day, every hour, and so on. Basically, the larger that the
quantity gets the faster that the quantity grows. If given enough time, the original balance will grow beyond all expectations.
No wonder POC is called the 8th Wonder of the World! To accumulate wealth at
a faster rate, a person would need to add additional principal as often as possible, without withdrawing any money from the
investment pool. A higher interest rate would also accelerate the process.(See page --) POC is the reason why the endowments at Harvard, Yale, Johns Hopkins, and many other universities and organizations
are in the billions of dollars and will be in the trillions of dollars in the next several centuries. For example, if Harvard
continues to invest in the same manner in the future as in the past, its endowment is on track to surpass the trillion dollar
mark within the next 90 years. (See Page--) The
Mechanism of POC The mechanism of POC
is a simple, doable, and very powerful method of investment. There are many compound interest calculators on the Internet
where all a person needs to do is fill in the appropriate information [principal, interest rate (e.g., 5%, 8%, 10%), number
of times per year interest is compounded (e.g., daily, monthly, annually), and number of years invested] to find out the future
value of an investment. Table 1 Table 1 shows how compound interest creates wealth. The example below shows the growth of a one-time investment of
$1,000 at 10% interest, compounded annually, for 25 years. The investment is started at the beginning of the year. Each successive
year, the interest is calculated on the sum of the original investment (principal), plus the interest that has accrued (accumulated). Y e a r | Principal of
$1,000 & Balance at the Start of Each Year in $ | 10%
Interest Compounded Annually in
$ (10% = 0.10) | Increasing Principal Base in $ (Interest is Calculated on the Sum of the Original Investment, Plus the Accrued Interest.) | 1 | 1,000.00 | 1,000.00 x 0.10 = 100.00 | 1,000.00 + 100.00 = 1,100.00 | 2 | 1,100.00 | 1,100.00 x 0.10 = 110.00 | 1,100.00 + 110.00 = 1,210.00 | 3 | 1,210.00 | 1,210.00 x 0.10 = 121.00 | 1,210.00 + 121.00 = 1,331.00 | 4 | 1,331.00 | 1,331.00 x 0.10 = 133.10 | 1,331.00 + 133.10 = 1,464.10 | 5 | 1,464.10 | 1,464.10 x 0.10 = 146.41 | 1,464.10 + 146.41 = 1,610.51 | 6 | 1,610.51 | 1,610.51 x 0.10 = 161.05 | 1,610.51 + 161.05 = 1,771.56 | 7 | 1,771.56 | 1,771.56 x 0.10 = 177.16 | 1,771.56 + 177.16 = 1,948.72* |
*The original principal doubles between Year 7 & 8 per Rule of 72. According
to the Rule of 72, money doubles in about 7.2 years at 10% interest, compounded annually. (See Page ???) 8 | 1,948.72 | 1,948.72 x 0.10 = 194.87 | 1,948.72 + 194.87 = 2,143.59 | 9 | 2,143.59 | 2,143.59 x .010 = 214.36 | 2,143.59 + 214.36 = 2,357.95 | 10 | 2,357.95 | 2,357.95 x 0.10 = 235.79 | 2,357.95 + 235.79 = 2,593.74 | 11 | 2,593.74 | 2,593.74 x .010 = 259.37 | 2,593.74 + 259.37 = 2,853.11 | 12 | 2,853.11 | 2,853.11 x .010 = 285.31 | 2,853.11 + 285.31 = 3,138.42 | 13 | 3,138.42 | 3,138.42 x 0.10 = 313.84 | 3,138.42 + 313.84 = 3,452.26 | 14 | 3,452.26 | 3,452.26 x 0.10 = 345.23 | 3,452.26 + 345.23 = 3,797.49** |
** The original principal quadruples between Year
14 & 15 per Rule of 72. 15 | 3,797.49 | 3,797.49 x 0.10 = 379.75 | 3,797.49 + 379.75 = 4,177.24 | 22 | 7,400.24 | 7,400.24 x 0.10 = 740.02 | 7,400.24 + 740.02 = 8,140.26 | 23 | 8,140.26 | 8,140.26 x 0.10 = 814.03 | 8,140.26 + 814.03 = 8,954.29 | 24 | 8,954.29 | 8,954.29 x 0.10 = 895.43*** | 8,954.29 + 895.43 = 9,849.72 |
*** The compound interest approximately equals
the original principal of $1,000 between Year 24 & 25. Although the build up of interest took roughly 24.5
years to match the original principal, the interest will double the original principal in the next 7.2 years per Rule of 72. 25 | 9,849.72 | 9,849.72 x 0.10 = 984.97 | 9,849.72 + 984.97 = 10,834.69 |
Difference between
simple and compound Interest Table
2 Table 2 shows the
difference in the end values of a one-time investment of $1,000 invested at both 10% simple interest and
10% interest, compounded annually. Both investments are started at the beginning of the year and the duration
of the investment is 8 years. NOTE: The reinvestment
of investment earnings is the essential step for exponential growth of the initial investment. Reinvestment makes a big difference
in the investment outcome over a period of time. Eventually,
reinvested earnings can grow so huge that the earnings create more earnings than the initial investment and, in turn, these
earnings create even more earnings. SIMPLE INTEREST $1,000 x 0.10 = $100 Per Year | COMPOUND INTEREST COMPOUNDED ANNUALLY See Table 1, Column 3 for
Calculations |
Y e a r | One-Time Investment in $ | 10% in
$ (10% = 0.10) | End Values in $ | One-Time Investment in $ | 10% in
$ (10% = 0.10) | End Values in $ | 1 | 1,000 | 100 | 1,100 | 1,000 | 100.00 | 1,100.00 | 2 | 1,000 | 100 | 1,200 | 1,000 | 110.00 | 1,210.00 | 3 | 1,000 | 100 | 1,300 | 1,000 | 121.00 | 1,331.00 | 4 | 1,000 | 100 | 1,400 | 1,000 | 133.10 | 1,464.10 | 5 | 1,000 | 100 | 1,500 | 1,000 | 146.41 | 1,610.51 | 6 | 1,000 | 100 | 1,600 | 1,000 | 161.05 | 1,771.56 | 7 | 1,000 | 100 | 1,700 | 1,000 | 177.16 | 1,948.72 | 8 | 1,000 | 100 | 1,800 | 1,000 | 194.87 | 2,143.59 |
At the end of 8 years, a one-time investment of
$1,000.00 will earn $1,800.00 with a simple interest rate of 10% and $2,143.59 with an interest rate of 10%, compounded annually.
The interest earned is $343.59 more at the compounded rate. Reminder: The difference in the interest earned would be greater
if the interest was compounded at a more frequent rate (e.g., daily, weekly, monthly, etc.).
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