Today’s Take: The secret to maximizing your wealth is compounding.
Imagine that it’s 1516, and King Francis of France is indebted to you for saving his life.
So, he gives you a choice…
He’s commissioning the “Mona Lisa” from Leonardo da Vinci as his gift to you. It’s his small way of saying, “merci.”
Or, you can have the equivalent in cash — around $20,000 — that you can invest at a 6% compounded annual rate.
But there’s one catch: Your heirs have to hold on to whatever choice you make. They can only cash in at the end of 2020, more than five centuries from now.
Your decision here is going to make all the difference in the lives of your heirs.
What would you do? Take the painting or the cash?
The Power of Compounding
If you passed on the painting and took the cash, you made the deal of the millennium!
At the end of 2020, the “Mona Lisa,” which now hangs in the Louvre Museum in France, is estimated to be worth between $1 billion and $2 billion.
The painting certainly went up in value, but your heirs wouldn’t have been “Jeff Bezos” rich.
Instead, you chose wisely. You took the $20,000 that compounded at 6% per year.
Your heirs are the wealthiest people who’ve ever walked the planet. They’re now worth over $95 quadrillion.
How much is a quadrillion? Well, a billion is a 1 followed by nine zeros. A quadrillion is a 1 followed by 15 zeros. And your heirs would have 95 of those. Wow!
This is just one of the money fantasies I swoosh around in my head. Sure, it’s a fun exercise, but more importantly, it demonstrates the power of compounding…
2 Rules You Should Know
Once you set the compounding machine in motion, it’s hard to stop. You can’t help but build a huge net worth. In fact, it’s inevitable.
Compounding makes a sum of money grow at a very fast rate. In addition to earning returns on the money you invest, you also earn returns on those returns.
And there are two rules of compounding that I want to share with everyone who’s willing to listen. Following these rules can make all the difference in how much money you accumulate.
- Rule No. 1: You don’t have to start with a lot of money to end up with a lot of money.
Just $1,000 invested into Intel would’ve turned into $3.2 million over 50 years. Invested into Apple, it would’ve turned into $1.2 million over 40 years.
And even if you’re starting to invest later in life and don’t have a 40- or 50-year runway … you can still benefit from the power of finding the right investment and let compounding do its magic. For example, just in the past 10 years, Microsoft increased by 10X!
- Rule No. 2: You never want to interrupt compounding unnecessarily. (I learned this rule from Charlie Munger, Warren Buffett’s business partner.)
You don’t want to be tempted to throw your hard-earned dollars away into the next trend of the day. Because any time you stop the clock of compounding, you’re letting go of higher potential returns over the long run.
The best thing you can do is sit tight and turn on the compounding machine … no matter how much money you’re starting with.
You can see for yourself how compounding can power your portfolio by checking out my Compound Calculator tool right here.
Founder, Alpha Investor