For me, compounding is one of the most exciting modules and the best one for turning clients into head spinning/exploding 'Scanners' style creatures. I give them the info, wait for the silences and count quietly.....one, two, three.....BOOM! Messy but fun.

Not for nothing was Compounding described by Albert Einstein (no stranger to head expanding concepts!) as the Eighth Wonder of the World.

It's such a big concept it's quite a challenge to get the magnitude of it across but I'm going to do my best over the next few segments. I would love some feedback as to whether I succeed.

Right, deep breaths all round.

Compounding is where you invest a sum of money, either in a cash vehicle or in an asset, and the gain (or return) you make in the first year is added to the original amount invested and, in the second year, the gain you make is calculated not only on the original amount plus the new amount (if any), but also on the gain made in the first year.

Clear as mud, right? You may understand the concept with your head but do you get it in your bones? The other problem people have with this is that they always equate compounding with the 4% return you can get from a building society. Forget that for a second.

Let's try again. I went to a Russ Whitney Property Seminar where I met an investor who said that he would never invest any money of his in a deal, unless he made a return of 100% every year.

How does that look?

If I invest #1.00 in the first year and I'm getting a 100% return/gain per annum, then going into year two I have #2.00. If the gain in year 2 is another 100%, then going into year three I have #4.00. Beginning of year four, #8.00. Beginning of year ten, #512.00.

** Pay attention - this is where it gets interesting **

Beginning of year fifteen, I will have #16,384.00. Beginning of year twenty, #524,288.00. Beginning of year twenty five, #16,777,216.00. Yes, that's sixteen million, seven hundred and seventy seven thousand, two hundred and sixteen pounds. In 25 years, starting with one pound.

Ready? Hold onto your heads! Scanner moment coming. Imagine if you put in another #1 in year two? And another #1 in year three? And yet another in year four?

Oh, I can hear the squeals of disbelief now!

But where do you get deals that give you a 100% return? Deals like that don't come along every day! Or..........I couldn't do that, I don't know how! Or...........but what if the property market drops or there's a war (the current favourite).

Okay, I'll grant you, deals like that don't come along every day. But that guy on the Whitney weekend is finding deals like that every three or four months or so. How many deals like that do you want in your lifetime? How many #1's do you need?

We have just come out of the debt module so you know that debt is a terrible thing precisely because of the compounding factor. We have now seen that the compounding factor can be a marvellous thing too.

 

© Nicola Caincross of The Money Gym 2008. No content to be reproduced without written approval of the author.

Nicola is a Wealth Coach, Author, Publisher and Speaker, and the Director of The Money Gym.

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