How the Principle of Compounding Can Help You Save More

Let’s face it—most of us aren’t saving.

We’ve been told a lot of things: to build up an emergency fund; to save money for weddings, down payments, and large purchases, to stash cash away for a dream vacation.

But when we sit down to figure it out, it’s overwhelming.

What do I do first? Do I have to sacrifice my spending? How much? Where? What if I make the wrong move and pick the wrong account?

Obviously saving is important, but we get caught up in the details and put it off. We tell ourselves we’ll do it later, but when later comes, that overwhelm hasn’t changed. We get stuck in a cycle of avoidance—often for years.

So how can compounding help us learn to break out of that and save more?


The Power of Compounding

First, what is compounding?

Let’s pretend you lose a job you’ve worked at for 10 years.

After several weeks of job searching, a contact puts you in touch with someone who wants to outsource a task to you. The job will only be for 30 days, and he warns you that the guy is kind of a weirdo.

Working for someone who comes with a disclaimer sounds like a questionable idea, but you go for it.

The weirdo turns out to be an eccentric billionaire who offers you two compensation packages for your work. You can either:

Earn $10,000 per day.
OR
Earn 1 penny the first day and double that until the 30 days are up: $0.01, $0.02, $0.04, $0.08…

Pennies? You knew he was crazy, but really?

$10,000 a day, though? That’s $300,000 in a month!

Your shoulders feel lighter, as you agree to the first package. A month later, you have $300,000. Not shabby.

But you just missed out on becoming a millionaire.

How One Penny Becomes $10.7 Million

$10,000 is a big number, and it’s simple to do the math. That’s a 6-figure income in a single month. Easy decision, right?

Not quite. Here’s a hint:

On Day 7, package 1 has paid you a total of $70,000. Package 2 has paid you $1.27.
On Day 14, package 1 has paid you $140,000. Package 2 has paid you $163.83.

So what? It still looks like the first plan wins. Two weeks in, and you’ve earned under $200? Great, you can get your teeth cleaned at the dentist.

In fact, it isn’t until Day 24—with only 5 days left—that something fishy happens to package 2:

Total Earned on Day 24: $167,772.16.
Total Earned on Day 25: $335,544.32.

Wait, what?

That’s more than $300,000.

You make 6-figures with package 1, but at the end of the 30 days, package 2 makes you not just 6-figures, but 8-figures.

In fact, that penny leads to a $10,737,418.23 compensation for your 30-day job.

30 day chart

That’s almost 36 times as much as the flat rate of $10,000 per day.

That’s the power of compounding.

Compounding Is About More Than Just Numbers

The doubling penny example is a common way to illustrate how compounding works, in both investing and saving.

Compound interest builds on itself, like a snowball rolling down a hill. You make money off the money you make, so an 8% return over 20 or more years can have incredible impact.

Time and small gains are your friend.

But this principle isn’t just about numbers. It can be applied to our behavior too—and used to combat the overwhelm and fears that keep us from saving money.

You don’t decide to save $1000 a month, then immediately cancel your internet, cell phone, and Netflix, and start eating nothing but 25 cent ramen packages and using homemade dry shampoo instead of showering.

Taking on an overwhelming challenge guarantees you won’t follow through and sets you up for failure—and feeling obliged to figure out all the details before you start saving is an overwhelming challenge.

You don’t have to know the details, and you don’t have to get it all right.

These are not your biggest barriers to saving money.

You just have to start.

Three Ways Compounding Can Help You Save

Here are three ways the principle of compounding can help you with your savings goals:

Start now. When you’re earning compounding interest, time is a key factor. The earlier you start, the better. This is why it’s important to take action now. Your biggest barrier isn’t figuring out what savings account to open—it’s getting started.

Start small. Saving small amounts will add up. Do not try to save $1000 by eating ramen and smelling bad, because you’ll quit in a day. Save $20 by canceling two monthly magazine subscriptions you don’t even read. Compounding doesn’t have to start big, because it grows with time.

Build momentum. When you do these two things, you prove to yourself that you are capable of making progress toward your goals and that the world will not end, just because you didn’t work out all the details before you started.

This builds momentum. Every small win helps overcome resistance, allay your fears, and combat the feeling of overwhelm that occurs when we try to do everything at once. Like compounding, your actions build on themselves. Pretty soon, you’re rolling along and you forget why it was so difficult to start in the first place.

So do not wait for the right time or the right knowledge, because it won’t happen. Start small, right now. You’ll thank yourself later.

Get Started Right Now

What are two things that stop you from saving? What’s ONE action you can take to begin?

Remember, start small and build momentum. Don’t wait.

Share your question or success in a comment below.

4 Comments:

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