Tuesday, April 16, 2013

Compounding Interest - A World Wonder

This is a blog about how money doubles and no, I don't mean scams. It was Albert Einstein's fault. He said it alright, Compounding Interest is the world's 8th wonder! Now, it's our turn to find out why he said that.

Look at his picture and his quote to the left again. We'll, it's obvious isn't it? If you understand the rule of money and it's benefits, the next best thing you would want is to make it work for you and not against you.

By this, you will know that compounding interest really has power. The good thing about making money work through compound interest is that, money never gets tired, or takes a leave of absence. Therefore keeps the business going without you having to work too hard. Make money work hard for you! After all, money will never get sick like you do.

Question:  So what is the formula for doubling our money?

"A voler sapere ogni quantita a tanto per 100 l'anno, in quanti anni sarà tornata doppia tra utile e capitale, tieni per regola 72, a mente, il quale sempre partirai per l'interesse, e quello che ne viene, in tanti anni sarà raddoppiato. Esempio: Quando l'interesse è a 6 per 100 l'anno, dico che si parta 72 per 6; ne vien 12, e in 12 anni sarà raddoppiato il capitale."                                                                                                                                  -Luca Pacioli

English please (roughly)...

"In wanting to know of any capital, at a given yearly percentage, in how many years it will double adding the interest to the capital, keep as a rule [the number] 72 in mind, which you will always divide by the interest, and what results, in that many years it will be doubled. Example: When the interest is 6 percent per year, I say that one divides 72 by 6; 12 results, and in 12 years the capital will be doubled." -Luca Pacioli

Ladies and gents, here comes the Rule of 72! 

It was Luca Pacioli who gets the credit for discovering such a wonder. An Italian mathematician, he presented the rule as a lecture in his Summa de Arethmetica in 1494.

In this formula, 72 is the constant when trying to figure out when your money will be doubling, divide it by the percentage, you will get the year(s) result. This is how our money begets money.

Here is a simple table for an example of this rule:

Now here... the current interest rate of Savings Account in the Philippines is 0.1%. When I was in grade school, a Junior Savings Account interest is 5%, notice how it's lowered over the years. The average current inflation rate is 3.4% and commodity prices still keeps rising every month and year. How can we keep up if our salary stays the same and our savings earns only 0.1% on interest?

Here, here... If you are given the opportunity to invest in a financial vehicle that can give you at least 4% and at most 50% which would you choose? The 0.1%? or the one that gives higher?

We'll lets depend it on your appetite for risk. Something to think about.

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