A Chinese Legend
According to legend, a clever craftsman tricked the emperor of China into promising an impossibly large payment for a chessboard he had made for him. The craftsman requested that the emperor place one grain of rice on the first square of the board, then double the number of grains for every subsequent square until all 64 were filled.
By the end of the first row (8 squares), the total number of grains was only 255. By the end of the second row (16 squares), the total had grown to 65,535. By the 41st square, the cumulative number of grains exceeded one trillion. Filling all 64 squares would require an astonishing 18 quintillion grains of rice in total.[2]
According to legend, the king turned the tables by demanding that the craftsman count each grain to verify the payment, making it effectively impossible, as counting them would take nearly 300 billion years.
The legend reveals two important lessons for investors. The first is that the effect of compounding can be astonishing. The second is that the human brain tends to underestimate the effects of exponential growth.
The Effect of Compounding
The chessboard example demonstrated the effect of repeated doubling (100% return). Now let’s consider a more realistic scenario: a 7% annual return.
A person who invests $50,000 at the age of 20 and earns an average annual return of 7% would accumulate $1,050,123 by the age of 65. But what happens if the investment is delayed by 10 or 20 years?
The table below shows that reducing the investment period by 10 years almost halves the final value of the investment, despite the time horizon shrinking by far less (from 45 to 35 years).
The effects of compounding appear slow at first but accelerate over time. The investors who begin later, at age 30 and 40, miss the rapid growth that occurs in the final decade, which is often overlooked because it seems so far off.
Countering your Intuitions
Warren Buffet is among the world’s most successful investors, with a net worth of over $100 billion. 97% of his wealth was accumulated after the age of 65.
The good news is that anyone can benefit from the power of compounding by starting to invest today. Of course, much depends on the ability to maintain a steady rate of return. That’s why partnering with a trusted financial advisor can be critical to achieving your long-term financial goals. A seasoned professional can help guide you toward the right investments and maintain a disciplined approach through market cycles.