The only formula you will ever need…(and it’s not e=mc²)

Nice catchy headline.  Unfortunately it’s not true (more on that later).  This one is almost magical, however.   This is how money makes money.  This is the simplified compound interest formula.  But don’t take my word for it:

Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it. – Albert Einsteincompound interest


 

A formula you should teach your children

Once you understand and appreciate it, there is no looking back.

It’s divided civilizations.  It’s helped to create some of the richest and some of the poorest people in the world.

  • P is Principal, the amount of money you start out with.
  • R/100 is the interest rate expressed as a decimal (ie 0.05 for 5%)
  • n is Number of times the interest is applied (ie number of years for annual interest)

How powerful is it?

Start out with $10,000 in the global reserve currency at 10% per year and after 40 years you’ll amass $452,593 gross.

Perhaps you can add 1,000 each year to the Principal? A variation on this formula shows you will have grown to $939,444.

But what pays 10%? Corporate bonds. But be careful on the ratings.

Of course inflation eats at this and tax has to be considered, but the power is immense.  It’s that apple-sized snowball that you roll from the top of the snow-covered hill.  It just grows and grows and grows.  But get this into your investing DNA and the investing road ahead, though tough, will be more enjoyable.  This formula is your light at the end of the investing tunnel.

Unfortunately. it isn’t the only formula we will explore.  Later, we will look in depth at another vital equation (I know what you’re thinking, “Black-Scholes”, but no – we will leave that well alone).

We will use that staple of school days arithmetic, standard deviation, to control our risk profile.

But until that time comes, make sure you understand Compound Interest; or as Albert said, you’ll be paying it.

Oh, and the correct relativity formula to cope with with particles of zero mass or objects that are moving is e²=(mc²)²+(pc)².

© The Naked Putz 2015

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