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Topic 2: The Destructive Power of Compounding
Most
Investment Books and
courses start with the Basic “Law” in the Investing
World – The Power Of
Compounding!
You can become a millionaire and more if you understand and use this concept! We will also start this course by discussing with the Power of Compounding and how it is killing us slowly!
Why is The Power Of Compounding a Silent Killer?
The Power of Compounding is a silent killer because there is a Natural Element in the Money World known as Inflation!
Before we go into more terminology and concepts, let us first explain the following 2:
From Wikipedia,
“In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.”
You and I have experienced it! People complain about it in newspapers and forums!
“The Plate of Chicken Rice is now $3.5 instead of $2!!??”
“I use to buy Coke for only 50 cents, it is not $1.2”
Some of you may be cool about it and say , “Inflation is only 3-4% per year! No big deal!”
Let us show you what is the Big Deal, but first, lets explain Compounding.
What is Compounding?
From Wikipedia, (The definition of Compounding Interest)
“Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also itself earns interest. This addition of interest to the principal is called compounding (i.e. the interest is compounded).”
Now, that we have the 2 definition, let’s see why most people are in trouble!
The Big Deal – When Inflation Is Compounded!
We know that the purchasing power of $1 erode over time! But just how bad is it?
Looking at Table 1, in the span of 40 years, the CPI has grown almost 3-4 times! And the CPI is calculated by a basket of common goods. What about other goods?
E.g. The common price of Coca Cola is about 50 cents some time back (about 15 years ago) and today (2009) it is at least $1.
15 years ago, your $1 is worth 2 Cokes. Today, the same $1 is worth less than 1 coke!
This happens because although Inflation is only 3-4% year, it is compounded. Meaning to say that a product, say Coke that costs $1 today, will cost $1.03 next year. The price increased by $0.03 that year. But does it mean that it will increase by $0.03 per year?
The answer is no. Because the following year, the 3% increase will include the $0.03.
The question is, has your pay at least doubled in 15 years?
The Story of the Boiled Frog!
Do you know that if you throw a frog into a pot of boiling water, it will quickly jump right out? Yes, it may suffer some injuries, but it will survive. Now, the interesting part is this… If we put the frog into the same pot with room temperature water, it will remain in the pot. Then what we do is to turn on the fire and slowly boil this frog. This unsuspecting dude will feel nice and warm while it slowly adjusts to the temperature and before it realises, it is boiled to death!
Tomorrow, we will see how Compounding can be our best weapon when we become a trained investor.
By the way, if you have not done so, join us for the next free live preview to become learn how to be trained investor. [Click Here]
You can become a millionaire and more if you understand and use this concept! We will also start this course by discussing with the Power of Compounding and how it is killing us slowly!
Why is The Power Of Compounding a Silent Killer?
The Power of Compounding is a silent killer because there is a Natural Element in the Money World known as Inflation!
Before we go into more terminology and concepts, let us first explain the following 2:
- Inflation
- Compounding
From Wikipedia,
“In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.”
You and I have experienced it! People complain about it in newspapers and forums!
“The Plate of Chicken Rice is now $3.5 instead of $2!!??”
“I use to buy Coke for only 50 cents, it is not $1.2”
Some of you may be cool about it and say , “Inflation is only 3-4% per year! No big deal!”
Let us show you what is the Big Deal, but first, lets explain Compounding.
What is Compounding?
From Wikipedia, (The definition of Compounding Interest)
“Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also itself earns interest. This addition of interest to the principal is called compounding (i.e. the interest is compounded).”
Now, that we have the 2 definition, let’s see why most people are in trouble!
The Big Deal – When Inflation Is Compounded!
We know that the purchasing power of $1 erode over time! But just how bad is it?
|
Looking at Table 1, in the span of 40 years, the CPI has grown almost 3-4 times! And the CPI is calculated by a basket of common goods. What about other goods?
E.g. The common price of Coca Cola is about 50 cents some time back (about 15 years ago) and today (2009) it is at least $1.
15 years ago, your $1 is worth 2 Cokes. Today, the same $1 is worth less than 1 coke!
This happens because although Inflation is only 3-4% year, it is compounded. Meaning to say that a product, say Coke that costs $1 today, will cost $1.03 next year. The price increased by $0.03 that year. But does it mean that it will increase by $0.03 per year?
The answer is no. Because the following year, the 3% increase will include the $0.03.
| Year 0 |
$1.00 |
| Year 1 |
$1.03 |
| Year 2 |
$1.0609 |
The question is, has your pay at least doubled in 15 years?
The Story of the Boiled Frog!
Do you know that if you throw a frog into a pot of boiling water, it will quickly jump right out? Yes, it may suffer some injuries, but it will survive. Now, the interesting part is this… If we put the frog into the same pot with room temperature water, it will remain in the pot. Then what we do is to turn on the fire and slowly boil this frog. This unsuspecting dude will feel nice and warm while it slowly adjusts to the temperature and before it realises, it is boiled to death!
Moral
of the Story : You Cannot, Not Invest!
Tomorrow, we will see how Compounding can be our best weapon when we become a trained investor.
By the way, if you have not done so, join us for the next free live preview to become learn how to be trained investor. [Click Here]
Topic 1: Welcome to the World of Investing
Topic 2: The Destructive Power of Compounding
Topic 3: Investing is RISKY?
Topic 4: Basic Lesson of Value Investing
Topic 5: 3 Steps to Identify A Winning Business
Topic 6: Getting Competitive Advantage
Topic 7: Understanding Financial Ratio
Topic 8: Pushing your Education further