August 20, 2007

Do You Understand Compound Interest?

The most powerful force in the universe is compound interest.
--- Albert Einstein
Would you rather get $10,000 today or a penny which doubles in value every day for 30 days?

Phil Harriman, former senator for Maine, asked this question earlier today in Banff.

Most of us would take the $10,000 today but after 30 days, the penny would grow to an astounding $5.4 million. We have trouble estimating exponential growth.

What about the effect of tax on the investment growth? With a tax rate of 35% (US federal and state), the $5.4 million drops to a miniscule $20,300. We have trouble estimating the effect of tax.

"What If"
Static examples are interesting, but what happens if the assumptions change? We can't easily estimate the outcome. Rather than guess, find out using the calculator I created with InstaCalc (a very nifty tool for bloggers and websites).

Deja Vu?
Avid readers with excellent memories may recall my earlier post on compounding, which gave more explanation of the calculations.


1 comment:

Anonymous said...

hey pramod,
you've asked a very vital question. essentially, i would go for the penny option to make it easy to double money.