Expert Advice

How Money Makes More Money

In this short clip, Rebalance IRA Investment Committee member and former chair of the IBM Investment Board, Jay Vivian, details the power of compound interest.

Jay Vivian: Albert Einstein was quoted once as saying that the power of compounding was the most important force in the universe. And I didn’t really believe it when I heard it, but I went and looked it up and I validated that it was true.

Compounding is when you get interest on something and then the next year you get interest on the original investment plus the interest. And the next year you get interest on the interest and the interest plus on the principal.

So if you start with $100, you get 20% interest, you have $120 the next year. You get 20% the next year, you don’t just get $20 more, you get 20% interest on the interest from last year, so it goes up, if you do the math, to $144 instead of $140. And it continues to accelerate that way. And after not too many years you’re now getting more interest on the interest than you are on the original $100. So that’s what compounding is, and that’s why he was so astonished by it.

There’s another story that I like to tell about that, though. And that is that years ago, 1,500 years ago, some famous — maybe not so famous — somebody invented the game of chess in India. And the raj, or whatever, the king or whatever of India, loved the game so much that he said, “I’ll give you whatever you want.”

And the inventor of the game said, “Okay, here’s what I want you to do. Take a chess board, just a little small chess board, and put one grain of rice on the first square and put two grains of rice on the second square and four grains on the third square and so on until you fill up the board and then give it to me. I want that as payment.”

So the king said, “Done. No problem at all.” And he went off and sent to the royal storehouse and said, “Give this guy however much rice it is this way.” Turns out that when you calculate that, I don’t remember the number, it was some astronomic… it’s like that’s as much rice as it takes to fill Mars or the Moon or something like that. I don’t remember what the number is.

But that’s the power of compounding. All you have to do is double something 64 times, which is how many squares there are in a board, and that’s the power of compounding. I like that even better than the Albert Einstein quote.