The Magic of Compounding
The big idea of compounding is this: You make interest on your money, usually determined yearly. Banks call this percentage an Annual Percentage Rate or APR. When you save, the bank pays you the APR on your money, and it grows. The next year, you have your starting cash plus what you earned in interest, and the bank pays you the APR on that amount. The amount keeps growing, and you keep drawing interest in the growing balance—that’s compounding!
We’ll delve deeper into inflation in a later section and discuss how it can impact your investment decisions and how you must take it into account when you are designing your investment plan. At this stage, the major takeaway is that money stuck under a mattress or in a bank savings account (at today’s interest rates) loses value every single day, 365 days per year.
The loss is hidden because the numbers don’t change. However, it is there, and you can see it happen every time you buy a can of soda or a loaf of bread if you pay attention. We don’t mind the three-cent increase in a single can of soda, but I hope the earning power examples above woke you up to the fact that inflation is the silent killer of wealth when we look beyond a single staple item and consider our total financial situation. An investment is supposed to make you money, so if you are not beating inflation, then it isn’t an investment at all.
Last Modified: 07/11/2018
This work is licensed under an Open Educational Resource-Quality Master Source (OER-QMS) License.
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