The power of compounding

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The power of compounding

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Compounding is often referred to as the “miracle” of the investing world. That is because investing even a small amount of money and keeping it invested over a long period of time has the potential to make it grow exponentially into a relative fortune.

Compounding, or earning interest on interest, is best described by an ancient story.

A Maharaja ruled the Indus Valley, in northern India, in the sixth century. Bored, he asked his court gamesman to develop a new game for him. The gamesman created chaturanga, the army game, the precursor of chess and played on a board of sixty-four squares. The Maharaja was delighted and asked the gamesman what he would like as a reward.

“Nothing much,” answered the gamesman, “Just one single grain of wheat on the first square, two grains on the second, four on the third, eight on the fourth, and so on across the board.”

In calculating the gamesman’s reward, the Maharaja discovered that, even before he was half-way across the board, he owed the gamesman more grains of wheat than existed in all of India. He solved his problem by ordering the gamesman executed.

The gamesman was earning interest at the rate of 100% per square, far beyond what we can expect. However, the principle of compounding interest remains the same. Earning interest on interest can add up over the long term.

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