Money Meets Medicine Podcast
MMM 87: What Chess and Personal Finance Have in Common
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Our brains are not wired to think exponentially. They are wired to think linearly. Maybe this explains why so many doctors, well people in general, don’t invest early enough and take advantage of one of our favorite tools- compound interest.
It has been famously said that “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” Today we explain the magic of compound interest and how exponential growth is going to blow your mind. The impact of compounding is massive!
Why Should You Care About Compounding Interest?
We are starting with a story that may or may not be true, but it is a really good story! It goes like this…
There was once a king in India who was a big chess enthusiast and had the habit of challenging wise visitors to a game of chess. One day a traveling sage was challenged by the king. The sage, having played this game all his life, all the time, with people all over the world, gladly accepted the king’s challenge. To motivate his opponent the king offered any reward that the sage could name. The sage modestly asked just for a few grains of rice in the following manner: the king was to put a single grain of rice on the first chess square and double it on every consequent one. The king accepted the sage’s request.
Having lost the game, and being a man of his word, the king ordered a bag of rice to be brought to the chess board. Then he started placing rice grains according to the arrangement: 1 grain on the first square, 2 on the second, 4 on the third, 8 on the fourth, and so on.
Following the exponential growth of the rice payment, the king quickly realized that he was unable to fulfill his promise because on the twentieth square the king would have had to put 1,000,000 grains of rice. On the fortieth square, the king would have had to put 1,000,000,000 grains of rice. And, finally, on the sixty-fourth square, the king would have had to put more than EIGHTEEN QUINTRILLIAN (18 zeroes) grains of rice, which is equal to about 210 billion tons, and is allegedly sufficient to cover the whole territory of India with a meter thick layer of rice.
It was at that point that the sage told the king that he doesn’t have to pay the debt immediately but can do so over time. And so, the sage became the wealthiest person in the world.
Think about that in the form of money instead of rice. There are compounding calculators out there that you can use, but since our minds don’t process exponentially, it is hard to really envision what it means. This story helps lay it out for you.
Here is a money example to help you see it.
-$1000 placed in market at age 50 until age 90 @ 8% interest = $21,725
-$1000 placed in market at age 20 until age 90 @8% interest = $218,606
10X return on same money for an extra 30 years of compounding.
Rule of 72
To figure out how long it will take your money to double, you take 72 and divide it by the interest rate. For example, 72 divided by 6 (percent interest) equals 12 years. It will take 12 years for your money to double. The higher your interest rate, the faster your money will double. If you invest $100,000 and it doubles every 6 or 7 years, imagine how much you will have after it doubles a few times!
Now, I want you to think about how compounding interest can work against you. I’m a credit card company and Jimmy opens a $10,000 credit card with an interest rate of 20%. If we take 72 and divide it by 20, the amount of debt will double in 3.6 years! So, in 3.6 years his debt went from $10,000 to $20,000! Obviously, this doesn’t account for any payments, but it shows to pay off your debt sooner rather than later! Compounding interest can be great for you, or bad for you depending on if it is on investments or debt.
Investing Early Versus Investing Late
As you can see from the examples above, the earlier you invest, the more your money can double. If you invest later in your career, you can make it work but it will be an uphill battle. The take home info here is that if you invest early, you invest less. The later you start, the more you must invest. If you find room now in your dreaded budget and get used to contributing now, it will be easier to invest more later.
Invest Early Example
If you start saving $75,000 when you finish residency at age 33, and stop investing at age 43, you will have contributed $750,000. At 8%, that will turn into just under $1.1 million by age 43.
If you don’t touch that $1.1 million and let compounding interest work from age 43 to 65, at 8% by age 65 you will have $6 million.
Invest Late Example
Let’s say you live it up… you don’t start really investing until you hit age 40. You decide to invest $75,000 per year for the next 25 years. In other words, you contribute $1.9 million.
At the end of those 25 years at 8%… you will have $5.5 million.
In other words, you’ll have $500,000 less at age 65, even though you contributed over $1 million dollars more.
Why? Because of the magic of compounding interest.
Compounding Interest Take Home
Compounding interest can work against you very quickly, or for you just as quickly. You need to get to where your money works for you. Don’t learn this lesson too late! Have the discipline and motivation to start now. Saving less earlier is definitely better than nothing at all because you’ll never catch up! Build that muscle while you are in residency because it works, and it will benefit you. It will be hard at first, but you will create a good relationship with money and will learn to understand that money can work for you. You will understand the power of compounding and the benefit of saving before you are an attending physician.
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