Episode 26 – The Compounding Genie


Hi everyone! And I’m glad you could join me today on our podcast or video on this Wealthy and Wise Wednesday. Hope you had a great week especially since this is probably going to be posted just a few days after Christmas.

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I hope you had a wonderful Christmas. Christmas is always a great time around our home. Even our older kids still love it, get a little bit anxious and excited. It’s really a lot of fun. And now that they have kids and when the grandkids at Christmas, it’s hardly anything any better than to be able to play a little bit of Santa Claus.

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So I hope you had a great Christmas. I also hope you have and are prepared for a wonderful 2018 both in all respects, physically, spiritually, mentally, and for us financially, making sure that you’re on track anywhere you want to be, financially speaking.

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Years ago, I used to tell this story about compound interest and it goes something like this. So let’s suppose you’re all warm and cozy in your bed tonight and you’re just dozing off and suddenly this genie appears in your room. And the genie has two things in his hands.

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In one hand, he says, “Look, I’ve got $100,000 right here in my hand today that I can give you, or in the other hand, I have one penny. And what I’m going to do is I’m going to come back every night and I’m going to double that penny. So here’s your penny today. Tomorrow, I’ll come back with 2¢ and then 4¢ and 8¢ and I’m going to do that for 30 days.

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And so, your choices, $100,000 today or a penny double for the next thirty days. And you don’t have your calculator with you and you’re wondering, “Man, what should be the answer here? $100,000 today, right now, no questions asked, or a penny doubling every day.”

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You do some quick math. Okay, 1¢, 2¢, 4¢, 8¢. Even by day 7, you only have 64¢. By day 10, $5.12. And you’re like, “Oh wow! I don’t know. That hundred thousand sure seems pretty good and you can quickly get to about day 12, day 13. Day 12, you’re at $20.48. Day 13, you’re at $40.96.

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So here you are, you’ve been going at this. The genie’s been showing up in your room, almost two weeks straight. Well, at 2 weeks, you have $61.92. First is the hundred thousand and that’s about as far as you can go with the math in your head real quick because the genie wants an answer. So what’s your answer? What would you do? $100,000 right now or a penny doubling every day

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It’s hard to answer that because so many of us probably think that $100,000 is a good bargain. Well, let’s just see what that looks like. So we know at day 14, so two weeks and we were at $61.92. At day 15, $163.84. Day 16 double that, 327.68. Now, let’s fast forward to day 20.

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Now day 20, we’re getting into some doe. Actually, let me back up today 18 because at day 18 we finally start thinking that this might be some money. Because at day 18, you have $1,310.72. You go, “Okay. So now, that’s starting to get somewhere. So that means what’s the next day? $1,300 x 2? $2,621. Now, $5,200. Now $10,400. Now $20,900. $41,900. $63,800. $167,000. Then $335,000. Then $671,000.

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Wow! This is getting exciting. $671,000. So let’s see where is break even. So at day 24, he’s bringing you 63,000. Day 25 he brings you 167. So if you were just patient for those 25 days, he brings you over $100,000.

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So now you’re way ahead of the game, plus all those days before, right? So day 26, 335,000. Day 27 671,000. Day 28 1.3 million dollars in your hands. Day 29 2.6 million dollars. And finally, by day 30 you get 5,368,709.12. Wow!

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Well, you can now get a glimpse of the magic of compounding. Although we don’t typically double every day, we can double over extended periods of time. And do that time and time and time again. Einstein actually calls this the eighth wonder of the world because it’s almost magical what happens with compounding.

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The problem is people. They give up compounding and they don’t let it work for them for really their lifetime. When you think about letting money compound from your early 20s to your late 60s when you might start taking income for retirement, that 45 years of compounding can do an enormous amount of good for you even if your rate of return isn’t huge.

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And if you’re taking advantage of some opportunities along the way with the money that you’ve saved in your capital account, we’ll call it, then you might have even taken or even might have had those years where you really compounded and grown. I always like to use Warren Buffett as the example because he’s probably maybe the greatest investor ever. So many financial advisors out there just have you investing, investing, investing, investing.

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Whereas Warren Buffet’s more of the approach that you put your capitalist side and you get ready for those opportunities that come along and then like he says, when it starts raining gold, you go out there with a washtub and you collect all you can. And that happens about every 10 years or so. We go through cycles where we have a boom and a bust or at least a growth spurt and then maybe a drop back.

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And Warren Buffet’s always been of the mind that you wait for opportunities and you buy what is commonly referred to as value investing. Even though he really doesn’t call it value investing because that can mean different things. What he’s really doing is he’s just taking advantage of markets that go on sale. This, of course, in his world is buying businesses which are usually stock companies but it’s also been for real estate for him.

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He’s done enormously well in real estate and that’s the same thing that we can do. What we have to do is we have to put our money aside into a compounding account and as that builds and grows, it gives us opportunities to take advantage of markets when they go on sale. As he says, buying $10 bills for five bucks. And how many bills do you want? Right? That’s kind of what happens after boom and bust cycles.

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Whereas your traditional financial advisors are just going to keep telling what you needed is keep throwing your money into the market every month, every month, every month, and they call it dollar cost averaging. I don’t want to go too much into that because I’m going to do a podcast and a video on dollar cost averaging here soon but let me just give you a glimpse of what that means.

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What that means is that in an up trending market like we’ve had in the last six years let’s say, every time you bought, you bought at a more expensive price. Right? So every month that that market went up and you put more money in, you paid more than you would of the month before.

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Now, we got to understand that not everybody has a lump sum but this is what the fallacy is for financial advisors to tell you about average rates of return because average rates of return are always based on putting money in at a point in time and letting it go for ten years. So in other words, if an advisor says, well the average rate of return on this for the last ten years has been 8% or whatever. That’s assuming you went back ten years and you dropped in your number, 10,000, 100,000, million, whatever that is. And let it go for ten years.

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Now, whole another subject, average does not equal actual returns but let’s just presume that that was the case, that at ten years ago you put in a hundred thousand dollars and it averaged 8%.

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Well, if you dollar-cost averaged along the way and if we take like I say the last six years into account, you’ve actually bought into a market that got more expensive every single month or certainly every single year. And as a result, you’ve lost. Dollar-cost averaging did not work for you. Dollar-cost averaging only work twice in the last ten years.

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So if we take the last ten years, there are only two years out of those ten where dollar-cost averaging made sense because the markets kind of fluctuated up down, sideways, and you were able to take advantage of that. So anyway, we’re going to talk more about that.

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The point is that what we want to do is put capital away, capital away. Save, save, save, save, save. Build up this big pile of money in a compounding account and especially a tax-free one. And as you guys know we like to use tax-free avenues for our money. So we build this up and then when the opportunities come along and we can buy ten dollar bills for five bucks, now we’ve got capital to go out with the wash tub and take advantage of it.

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So the compounding effect of money is just almost magical and I want you to take advantage of it. I’d never want you to miss a day. That’s why it’s so hard to get back yesterday. And why delaying the time where you start saving is just potentially a killer because especially as the younger you are, you want to have as many years as you can to compounding growth.

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So compound, grow. Put away money as fast as you can and build up this pile of capital so you can take advantage of opportunities so that you don’t maybe, we’d all love to have a magic genie show up but since usually it’s not a genie going to double your money every day. What we want to do is make sure we are in opportunities where we can do that ourselves. What do you think of that?

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That is an amazing concept. So as we go into 2018, get yourself focused. Pay yourself first. Really one of the most magical things you can do is pay yourself first. Goes way back to the time when that book Richest Man in Babylon was written where they said you should pay yourself first. And when you do that and you set aside 10, 15, 20% of your income and pay yourself first, get it set aside, so that you’re building up that compounding account and then eventually take advantage of wonderful opportunities as they come along and they will come along.

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Who knows if we’re in a bubble right now? It’s just crazy out there. There’s really no value to most of the stocks that you might look at and it’s hard to say, “Wow! This is a good value right now, just everything’s over-inflated.” So it’s a good time to maybe, I don’t know, pull some money off the table, set it aside, get it again in a compounding account and then wait for those opportunities.

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So there you go! Welcome to 2018 in just a couple of days. I hope you have a great year ahead and all these that you put together. Keep listening to the podcast. Make sure you subscribe. Subscribe to the videos. Stay informed. We’re gonna do our best to keep you on top of these financial topics and some tips and tricks to make sure that you’re getting where you want to be financially. So that’s it. Hope you have a great week. And I’ll talk to you next week. Take care!

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