Vicki Robin

The magic of compound interest

In Uncategorized on August 7, 2009 at 8:32 PM

When my parents took me down to the bank to open my first account, I was also given my first lecture on the “magic of compound interest.” Back then the interest on my little account was probably 3.5%. I was told that if I kept that $10 in my savings account, I’d have $20 by the time I graduated from high school. “Where does the extra money come from?” I asked. No good answer came, other than “the magic of compound interest.”
Interest compounding means they figure your interest based on the total of your original investment PLUS all the interest you’ve earned to date. It shortens the time until doubling. But even without compound, any percent growth means there is eventually a doubling time. At 3.5% interest, it would be 14 years to $20.
Investing in CDs or Bonds means you are skimming off the increase every year, but never touch the principle. It’s a goose that lays golden eggs for years and years. This is what I’ve done. I’ve lived off interest income for nigh on to 40 years – with no reduction in my nest egg.
This magic, though, can work against you.
When you are a debtor rather than a lender, your debt doubles according to the interest rate on your card. If you pay 10% on your balance, your debt will double in 7 years. 14% doubles in 5 years. See what I mean. The magic is NOT in your favor.
Now here’s a lesson I got in 1989 and never forgot. These growth rates apply to any process. With regard to the big environmental issues of our times, climate change for example, any small annual increase in the problem will eventually lead to double trouble. Just 3% more carbon in the atmosphere per year (increase in cars, increase in manufacturing, increase in new buildings with heating and cooling) accelerates the problem. As a rule of thumb, you can figure a growth rate of 7% will lead to a 10 year doubling time.
Here’s an illustration. Imagine there is one lily pad in a pond and lily pads double daily. Day two there are 2. Day three there are 4. Day 5 there are 8. Imagine that it takes 20 days to have half the pond covered with lily pads. When will the whole pond be covered? Day 21. On day 19, only a quarter of the pond is covered. On Day 18 only 1/8 of the pond is covered. If someone was concerned about lily pads choking the other pond life, they probably wouldn’t see the problem until it was too late.

The personal lesson here is to be sure you have that magic working for you, that you are increasing what you want more of – like money – and not what you want less of – like debt.

The larger lesson is that expanding consumption (for both haves and have-nots) means more of what we don’t want collectively. Growth on a finite planet is like that pond. Unchecked it chokes out the rest of life.
Which brings us back to Your Money or Your Life. Do the program and you’ll get out of debt and have savings – making interest work in your favor. Also, do the program and you’ll find you have a better life on probably less money and fewer things than you ever thought possible. Which means you are doing your bit for a healthier world.

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