Given the choice of a million pounds today, or 1p doubled every day for a month, which would you choose?
I have no doubt that many readers would pick the million. After all, £1m is a life-changing amount of money. With a million in the bank, you could perhaps retire early and travel the world. That amount of money brings significant choices.
Yet would picking the million be the best choice of the two options? Could it be possible that taking 1p, and doubling it every day for a month, could be the better option?
Let’s run the calculations. You may be surprised at the result.
The table above shows that, incredibly, 1p doubled every day for a 31-day month, would grow to a staggering £10.7m. It’s quite unbelievable, isn’t it? I was surprised myself – I had to check my calculations to make sure I didn’t have the decimal place in the wrong spot.
Those that were willing to take the 1p, and have it doubled every day for a month would end up with over 10 times the amount of money than those who opted for the million straight up. So, what’s the key lesson here?
The power of compound interest
The calculations show the incredible wealth-building power of compound interest. This is interest that is earned on previously-earned interest.
In finance, compound interest or ‘compounding’ is a fundamentally important concept to understand, and capitalise on, because it can result in the exponential growth of your money over time.
Over the long term, it can transform even a little amount of money into a huge amount of wealth. The important thing to realise is that the earlier you start compounding, the larger your wealth can potentially become.
Compound with growth assets
Now, unfortunately, it’s not realistic to expect to be able to double your money every day. Yet, don’t let that put you off. If you’re willing to invest your money in growth assets, such as shares, funds, investment trusts and ETFs, you can still compound your money at a very healthy rate and grow your wealth significantly over time.
Plenty of investors are regularly making returns of 10% or higher, from investing in these kinds of growth assets. For example, shareholders in Unilever have seen their wealth grow at around 12% per year, over the last five years. Investors in Nick Train’s Global Equity fund, a highly popular growth fund, have done even better and have seen their money grow at nearly 20% per year over the last five years.
While past performance is no guarantee of future performance, these figures show that it’s possible to grow your money at a formidable rate if you’re willing to invest in growth assets. And these kinds of returns can generate very impressive results over the long term. For example, £20,000 invested for 30 years at 10% per year, would grow to £350,000.
Over a long-term investment horizon, the power of compounding can boost your wealth significantly. With time and patience, compounding can transform even just a small amount of money, into a large, life-changing sum. The sooner you start compounding, the more wealth you could potentially generate.
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Edward Sheldon owns shares in Unilever. The Motley Fool UK owns shares of and has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.