There is much wisdom in fables and folklore. I recently came across one such story that offers a valuable lesson on the power of compounding.
The Indian fable known as the Legend of Paal Paysam involves a local king, lord Krishna and a game of chess.
The king was renowned for his love of chess, and would infamously challenge wise visitors to play a game with him. The king would offer his opponent any treasure or prize he wished if the challenger could best the king in their match.
One day, a traveling sage arrived in the realm – Krishna in disguise – and was challenged to a game by the king. When asked to name his desired reward, the sage noted that he was a man of modest means, and did not need much. All he wanted was a few grains of rice, placed on the chess board in the following manner: Every square would have double its predecessor. So, there would be one grain of rice in the first square, two grains in the second square, four in the third square, eight in the fourth square, sixteen in the fifth square, and so on.
The king agreed, and they started the match. Much to the king’s surprise, he was beaten by the sage. A man of his word, the king had a bag of rice brought out to the chess board. He began placing the grains of rice on the board, as was their agreement. But the king quickly realized that he could not pay his debt; the exponential growth after each subsequent square on the board was much larger than he imagined.
On the twentieth square, the king would have had to put 1,000,000 grains of rice. The fortieth square would require 1,000,000,000 grains of rice. And, finally, on the sixty-fourth square, the king would have had to put more than 18,000,000,000,000,000,000 grains of rice. At this point, Krishna revealed his true identity and told the king he did not have to pay his debt just then but could do so over time, much to the king’s relief.
This simple story is a potent illustration of the often-unexpected power of exponential growth and compounding. We talk a lot about compounding, and how it helps the rich get richer. Sure, that is true – 10% of $1 billion is $10 million, after all. But at its heart, compounding is just the mathematics of how growth can work, whether you’re wealthy or not.
Let’s end with a real-world personal finance example. Say you earn $45,000 a year, receive 2% annual raises and begin contributing 10% of salary each month to a 401(k). Your investments earn a 6% annual return. When you allow your investment earnings to compound over time, you can clearly see the growth they add to your account balance. At the end of five years, for example, your monthly investment gains could amount to roughly one-third of the monthly amount you’re contributing on your own. And by eight years, your monthly investment earnings could equal more than half of your monthly contributions.
It’s not magic; it’s math. So, consider working with a professional to see how you can put compounding to work for you, grain by grain.