I recently sat in a university course that required writing a small Java program to calculate compound interest. Enough students struggled with this concept to spark me to write this little article.
Whether it's a traditional savings plan or newer concepts like earning cryptocurrency by "proof of stake", having a solid understanding of "compounding" or compounding interest is important. This concept can be one of the most powerful and important concepts to understand and use in your life, particularly if you want to build a strong financial future.
Let's say you are Fred Flintstone and your currency of choice is "clams". You manage to save 10,000 clams working a lot of overtime and a side job at the local quarry.
Fred puts these 10,000 clams in an investment of some type (perhaps he has a bank account or a mutual fund or buys a cryptocurrency that provides rewards for "staking" his clams) and that investment returns 5% of his balance each year. (this is optimistic for modern savings-type account, but not so for more aggressive investments).
The next year Fred will have 10,500 clams.
Now, Fred may think "boy, I should buy a new bowling ball and a diamond for Wilma with my 500 clams". This is a bad choice, and his friend Barney tells him so.
If Fred were to spend those clams, he would leave the initial 10,000 clams to just earn another 500 for the next year.
If Fred were to let those earned clams remain, he would have a balance of 10,500 to earn interest the next year. The interest, plus his initial investment would compound his earnings.
The following year's interest + investment would equal $11,025.
Fred decides to let those clams stay again and the following years' interest keep earning him more and more currency.
After 10 years, it would break down like this:
Fred would have 16,288.95 clams at the end of 10 years. Not bad for being disciplined and leaving his investment be.
Now, let's kick it up a notch. Fred decides he wants to put away some of his extra clams each month, rather than just earn interest on one single big deposit.
He puts away 500 clams each month into his investment account, totaling 6,000 extra clams each year.
As you can see in the table below, rather than having 16,288.95 clams at the end of 10 years, he has a whopping 93,784.97 clams put away!
Now, apply this idea to your "buy and hold" Bitcoin investment or an educational savings account for your kiddo, or to getting an IRA started for yourself.
The time to start saving up is now! While cryptocurrencies are volatile and seemingly unpredictable, finding a solid one that offers "proof of stake" can take advantage of this concept. There are several out there to research.
Remember too, there is a flip-side to this coin. Credit cards! Some credit cards get away with charging a whopping 20% interest. That interest compounds each month. So, basically the consumer becomes a bank for that credit card corporation that is earning a crazy amount of compound interest on credit card balances that aren't paid off each month.