Money Matters – Skloff Financial Group Question of the Month – September 1, 2019
By Aaron Skloff, AIF, CFA, MBA
Q: What is worth more $1 million or one penny doubling in value every day for a year?
The Problem – Determining What is Worth More, $1 Million or One Penny Doubling in Value Every Day for One Year
The internet age fed our desire for immediate gratification. All but a decade ago, our online orders would arrive in a week’s time. Now, we expect next day or same day delivery. Our desire for immediate gratification can cloud our ability to make decisions.
The Solution – Put Aside Immediate Gratification and Calculate What is Worth More
Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t…pays it.” Compounding allows an investor to earn interest on interest or earnings on earnings.
Numbers Speak Louder Than Words. Let’s look at an example of two investors, Logan and Madison. Both Logan and Madison are asked the same question, “What is worth more, $1 million or one penny doubling in value every day for one year?” Logan, who desires immediate gratification, chooses $1 million. Madison remembers reading an article on the power of compound interest and chooses one penny doubling in value every day for one year. With great anticipation, Logan and Madison want to know the answer.
For the sake of simplifying the exercise, we exclude the impact of the inflation, taxes and other factors that could adjust the answer. Now, back to the fun part. On day two the penny’s value doubles to a whopping two pennies. Compound interest dictates that the value of two pennies doubling in value (remember, you earn interest on interest) to four pennies on day three. Compound interest grows one penny into more than $1 million in less than one month. By the 28th day, those pennies add up to $1,342,177.28. By the 56th day, you have $360,287,970,189,640. In English that translates to three hundred sixty trillion two hundred eighty-seven billion nine hundred seventy million one hundred eighty-nine thousand six hundred forty dollars.
By the 365th day, those pennies add up to $375,766,813,243,813,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000.00. In English that translates to three hundred seventy-five quattuortrigintillion seven hundred sixty-six trestrigintillion eight hundred thirteen duotrigintillion two hundred forty-three untrigintillion eight hundred thirteen trigintillion dollars. Clearly, the answer is one penny doubling in value every day for one year is worth more than $1 million. Had it been a leap year, compound interest would have doubled the value of the pennies one last time.
Logan is absolutely amazed when he learns the answer, while Madison feels as smart as Albert Einstein.
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Action Steps – Put Aside Immediate Gratification and Calculate What is Worth More
Learn from Logan and put aside immediate gratification when making financial decisions. Rather than relying on instinct, run calculations. Whether you are saving for a college education, a vacation home or a comfortable retirement, allow time and compound interest to work for you.
Aaron Skloff, Accredited Investment Fiduciary (AIF), Chartered Financial Analyst (CFA), Master of Business Administration (MBA) is CEO of Skloff Financial Group, a Registered Investment Advisory firm specializing in financial planning, investment management and benefits for small to middle sized companies. He can be contacted at www.skloff.com or 908-464-3060.
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As someone deeply immersed in the world of finance and investment, I find the question posed in the article about the comparative value of $1 million versus a penny doubling in value every day for a year to be an intriguing exploration of the power of compound interest. My background as an expert in the field allows me to shed light on the concepts involved and provide a comprehensive understanding.
Firstly, the article correctly emphasizes the significance of compound interest, quoting Albert Einstein's famous statement, "Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t…pays it." This underlines the central theme that compounding enables the accumulation of interest on both the principal and previously earned interest, leading to exponential growth over time.
The scenario presented with investors Logan and Madison serves as a practical illustration. Logan, driven by immediate gratification, opts for the apparent simplicity of $1 million. On the other hand, Madison, equipped with the understanding of compound interest, chooses the penny doubling every day. This dichotomy mirrors real-world decision-making where individuals must balance the allure of immediate rewards with the long-term benefits of patient and strategic financial planning.
The numerical example in the article vividly demonstrates the astonishing impact of compounding. The exponential growth of the penny's value, doubling daily, culminates in a staggering amount by the end of the year. The use of specific figures, such as $375,766,813,243,813,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000, highlights the magnitude of the difference between the two choices.
Furthermore, the article wisely acknowledges the simplification of the exercise by excluding external factors like inflation and taxes. While this simplification aids in illustrating the core concept, it's crucial for readers to understand that real-world scenarios may involve additional complexities that could impact the final outcome.
In conclusion, the article effectively communicates the importance of putting aside immediate gratification in financial decision-making and encourages readers to calculate and leverage the power of compound interest. The actionable steps suggested, such as running calculations and allowing time and compound interest to work in one's favor, align with fundamental principles of sound financial planning. As an enthusiast in the field, I appreciate the practical insights shared by the author, Aaron Skloff, and believe they can contribute positively to individuals seeking financial wisdom.
