The magic and misery of compounding
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The president wants to stop unscrupulous brokers from flogging investments to consumers that kick back fees to the brokerage. These kinds of dodgy investments cost consumers one percent a year, on average. That may not sound like much, but one percent a year is worth a lot to a saver, thanks to a magical thing called compound interest.
Pop quiz: Would you rather get $10,000 a day for 30 days or a penny that doubled in value every day for the same 30 days?
It’s a question often used to show the often counter-intuitive power of compounding. By day two, Option A yields $20,000, while Option B is a mere two cents. It feels like a no-brainer, right? But by the end of the month, Option B is the clear winner at more than $5 million, compared with Option A’s $300,000.
The math is clear, but compounding is often difficult for us to wrap our heads around, says Andrew Meadows with Ubiquity Retirement + Savings, which provides retirement accounts for small businesses.
“It’s essentially interest earning interest,” says Stephen Brobeck, the executive director of the Consumer Federation of America. What you earn goes back into your account and now you earn interest on that, plus your initial investment.
The longer you leave the money, the more it snowballs. But that snowballing can work against you if you’re in debt and paying interest instead of earning it, cautions Diane Lim, an economist at the Committee for Economic Development.
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