What is the Compounding Effect & Why You Should Care
There is a common misconception: More money means more wealth.
Fellow whales, here’s the truth: more money gives you more access to wealth when managed properly.
Did you know 24% of high-income earners making over $100,000 a year are still living paycheck to paycheck—Yikes! That is not a very Whale-like lifestyle! Avoiding this dichotomy is not about frugality—Frugality will only get you so far!—It is about investing!
Wouldn’t you rather sidebar a two-week vacation to Italy and invest a large lump sum of money on a monthly basis, so you can retire at 45, summer in Capri and then reside in your Miami condo investment for the winter? We say YES!
Time is Money!
Ok so let’s talk CRE investing…
Traditionally, commercial real estate investments required large amounts of capital, so only investors with clout and deep pockets were able to tap into this type of investment opportunity. Even more limiting, you had to be an accredited investor to even qualify. So, those of us working hard to get ahead, and save with the intention of wisely investing, could not access this opportunity that offers less risk and more stability than the stock market.
In the new age of democratization of real estate investing, however, you do not need a lot of money to get started and in the case of School of Whales, you only need $500.
The sooner you invest the better. Inflation risk is a real threat to your purchasing power. If you do not need the capital liquid in the near future, do not let it rot in the bank! My savings account earns something very sad like 3 cents per month. Let’s say I want to save 1.5 million dollars — I could retire…well, never…
The Power of Exponential Growth
Still not convinced? Let’s look at the compounding effect.
First, I will walk you through a fictional scenario to serve as our baseline for comparison: You have $100. A magical figure appears before you and says that this $100 will increase 10% each month for half a year. Looking at it mathematically, see below:
Month 1: $100 + (100 *.10) = $110
Month 2: $110 + (100 *.10) = $120
Month 3: $120 + (100 *.10) = $130
Month 4: $130 + 100 * .10) = $140
Month 5: $140 + (100 * .10) = $150
Month 6: $150 + (100 *.10) = $160
In this hypothetical fiscal period, you would make $60 in total.
Now I will walk through this same scenario only taking into account the compounding effect. We will round to whole numbers for the sake of this exercise.
Month 1: $100 + (100 *.10) = $110
Month 2: $110 + (110 * .10) = $121
Month 3: $121 + (121 * .10) = $133
Month 4: $133 + (133 * .10) = $146
Month 5: $146 + (146 * .10) = $161
Month 6: $161 + (161 * .10) = $177
In this hypothetical fiscal period, taking into account the compounding effect, you would make $77 in total. When the dollar amount is compounded, you end up making more money faster ($60 vs. $77).
The best part of all, the growth is exponential. So, the rate of growth increases with each compounding period. Instead of a linear line, this line will curve increasingly upward until it is practically vertical. The power of compounding is one of the most powerful forces in investing. It allows you to accumulate large returns with little initial capital. But, again, this doesn’t mean luxury Euro trips with your 10 closest friends. The money you make from this mathematical phenonium should be reinvested.
Key Takeaways
In the context of School of Whales, the compounding effect would come into play if you elected a recurring investment option. Instead putting more money into your savings account on a monthly basis, you can continue to add to your existing investment; thus, creating the effect of exponential growth for your accumulating capital.
Regardless of whether you invest in School of Whales or another low risk, well diversified portfolio, do it today! Your money sitting in your checking or savings is growing at a much slower rate than the Federal Reserve’s target rate of inflation, so you are loosing money every year that passes. And if you really have your eye on the prize in terms of early retirement, do this for 20 years, in secure, diversified investments and retire a relatively rich man or woman.