Don't Keep It Simple, Silly
Sometimes, and only sometimes, complex is better than 'simple.' When and how? Read on.
Let me take you back in time.
Class VI-A, Period No. 3: Mathematics
As the bespectacled teacher walks into the class, she's greeted by that sing-song chorus we all used to love - "Gooood Mooorn-ingggg Ma'am".
Note: No gender bias, my math teacher in school was a “she.”
Little do we realise that we are going to get the most important math lesson of our life.
She scribbles on the blackboard:
"Simple Interest & Compound Interest"
She narrates while writing,
P x I% x N = Simple Interest per annum (p.a - means per year)
P (1+I%)^N - P = Compound Interest,
Where P = Principal amount, I% = Interest Rate per period and N = No. of periods
As soon as she writes the second equation, my head spins a little. Now here's something complex, and it makes me feel uneasy. I swiftly start breaking it up in my notebook, and then rattle the brains of my teacher.
She says, "Compound interest is principle multiplied by interest rate factor to the power of no. of periods given in the question. Now solve Q3, Page 52 of your NCERT book. And please, no R.D. Sharma queries will be entertained.”
Dejected, I follow the instructions, and miss the essence of the lesson.
That's right. The most important lesson, converted into a formula, only used to solve questions.
Let's right this wrong, once and for all.
Imagine this.
You and your friend (Karn) give Rs. 1,00,000 each to Ekta, and she promises to give you 10% interest on the same. However, Ekta puts these two options in front of you:
1. Collect interest amount (Rs. 10,000) every year
2. Let Ekta keep the interest amount every year and give you 10% on that interest amount as well
You choose option 1, while Karn chooses option 2.
Both of you decide to do this for 5 years, at the end of which, Ekta will return that initial Rs. 1,00,000 to the two of you.
Every year, you get your Rs.10K, on time, show it off to Karn, and spend it on the latest, coolest gadgets. You don’t understand why Karn always has a smirk on his face, when you show him the money you got.
5 years later ...
The three of you meet in a cafe, and Ekta gives you and Karn Rs. 1,00,000 each. She takes out another Rs. 61,051 and gives it to Karn.
Karn smiles at you slyly.
You are aghast. What the hell just happened!
You say, "Ekta, you gave me only Rs. 50K over these years! Why are you giving Karn Rs. 61K. That's absolutely unfair. Cheating."
Ekta: "Calm down. Karn left his interest amount with me. Over the years, I paid him interest on his initial amount as well as the interest that he ‘re-invested’. You asked to keep things ‘simple’, and wanted the interest every year. He, on the other hand, wanted time and money to work in his favour, and so let me 'accumulate' the interest and pay 10% on that as well."
You kick yourself for making the stupid choice.
You write down in your journal:
Karn doesn’t buy stuff he doesn’t need.
Karn is patient and re-invests his interest.
Karn lets money work for him.
Karn is a smart financial decision maker.
Be like Karn.
Let me tell you another story. This time, an Akbar-Birbal one.
One day, Akbar asked Birbal, how much would Birbal charge for his services, to which Birbal replied:
Imagine a chessboard (with 64 squares). Just keep two grains on the first, and keep doubling as you move to the next square (2,4,8,16,32 … and so on). I will take only what’s on the 64th piece of the chessboard. That’s all.
Akbar quickly agreed to this.
When the ministers started piling grains up this way, they noted that by the end of the 64th square, the grain count was 1,84,46,74,40,73,70,95,00,000(That is, 2^64. Don’t try and check this on your calculator, it throws an error. Here, Google Baba to the rescue).
Basically, Akbar would have to give up his entire kingdom to Birbal, to pay this off.
Birbal 1 - 0 Akbar.
Now, some would feel, “Yaar, you are telling so many stories. What’s the takeaway?”
The takeaway, my friend, is to make compounding your best friend.
Now, our hunting-gathering ancestors did not need complex mathematics to survive. Since most of our cognitive (fancy term for anything to do with the brain) development happened during that time, we did not evolve to intuitively understand the effects of compounding.
This is what I look at, at least once a week, to remind me of the power of compounding. The graph shows how Re. 1 grows over 30 years, compounded @20%.
Watch the graph again. Year by year. Take it in.
That’s right. Rs. 1,00,000 invested today growing @ 20% a year becomes Rs. 237 lakhs after 30 years.
To achieve financial freedom, you need your money to make more money. Even while you sleep. You can be lazing around, but your money will serve you like a loyal servant. And, the best thing about the compounding effect on money is that it has time on its side.
As you can see in the picture above, the longer you keep that money invested, the larger the returns.
Hence, it is advisable to start investing your money right away. Every day you wait, you lose.
As we said at the beginning, not all things simple are good. Not all things complex are bad.
So, starting early, or regretting later?
Your choice.
We did our job.
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