What do a folded piece of paper and your savings portfolio have in common? When exponential growth is applied, both can increase to spectacular heights.
There’s a well-known theory that a piece of paper folded 45 times over can reach the moon. It may seem hard to wrap our minds around, and while no one has tested that theory, it makes sense in reality when you factor in the power of exponential growth. Compounded interest can have a similar effect on your savings. Every savvy investor knows that the holy grail of investing is compounded interest. Compound interest, in simple terms, is when your investment grows exponentially. This type of exponential growth is one we’re most familiar with, especially in the world of finance, but this type of growth rate isn’t only limited to investing. It’s rooted in many different facets of our day-to-day lives, often without us even noticing.
Compound interest means that the interest on a loan, investment, or deposit is calculated based on both the initial amount and on the interest earned over time, so you earn money on both the money you invested and the interest you earn, leading to a much higher rate of growth. As a basic example, if you’re gaining 10% monthly compound interest on an initial investment of $100, the first month you’d have $110, the second $121, the third, $133, and so on. After a year, your initial $100 investment would be $313, which may not seem like a big amount, but still adds up to over a 300% increase.
In finances, we know compound interest returns can cause exponential growth. Exponential growth is the process of calculating the increase of quantity over time, often creating a curved result, known as an exponential function. If you were to view it on a chart, exponential growth would have time on one axis and quantity on the other.
Compounding is one of the most powerful tools in the finance world, yet some investors still don’t take advantage of savings opportunities or accounts with compound interest. Instead, they might shift their focus to expanding their portfolios with new assets. While diversifying your portfolio is never a bad idea, compound interest should be seen as the bread and butter of anyone whose goal is saving or investing their money.
To understand how much of an impact compound interest can have on your finances, let’s examine how exponential growth looks in a very relevant example.
While compound interest is a positive example of exponential growth and a high rate of growth is what every investor hopes for, the effects of something growing exponentially over a short period of time isn’t always a cause for celebration. The Covid-19 pandemic is the perfect example of this. Towards the start of the pandemic, many countries were reporting that the number of infected citizens was doubling at a regular pace. In the UK, for example, the number of sick in March 2020 was doubling every three to four days. This accelerated rate of spreading is what made Covid-19 so impactful and threw the world into a panic.
While the implication in this example of exponential growth is negative, when it comes to your own investments, exponential growth is often positive. Take the example of the invested $100 we mentioned earlier. Growing by a few dollars each month might not be considered “fast” by most standards, but if you begin investing larger amounts, add monthly contributions, and let your investment sit over a number of years gaining compound interest, you’re likely to double your initial investment.
While you’ll probably never fold a paper dozens of times to reach outer space, compound interest is a very real way exponential growth works to help you gain interest on interest so that you can grow your wealth faster. The benefit is that you can start saving with a smaller amount of money and still reach your savings goals after taking compound interest into account. That leaves you with more flexibility to play with the rest of your money, leaving you room to still work on diversifying your portfolio.
Quantifying the effects of your compounded interest can be difficult to visualize or calculate on your own. One of Vyzer's core values is empowering you to control and manage your own wealth, specifically your alternative investments, showing the effect of compound interest on your finances holistically (among many other valuable insights). Vyzer portrays, in the clearest way possible, how you've successfully compounded the growth of your wealth over time and how this rate of growth can impact your future.
