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A multidisciplinary lens on investing!
Laksh Raghavan
August 18, 2024
Today’s post will draw insights from complexity, psychology & mathematics and apply it to the field of investing*. This post is not intended for wall street investors or day traders. It is more for retail investors (e.g. someone in a corporate job) who are likely investing for their retirement.
My interest in investing began long before I got my first job - from trivia and quizzes! Here is one of many such questions that reveal interesting insights - ones that I felt were compelling enough to adopt and take action in real life.
X and Y are both 23 years old when they land their first job. X starts saving into his retirement account (say PPF in India or the 401k in USA.) immediately at the rate of One Thousand Indian Rupees per month. But, Y waits 8 years (until he’s 31) to start saving into his PPF and then contributes the same monthly amount (Rs. 1000/month) as X.
X stops contributing to his retirement account at age 33 (which represents 10 years of saving) and Y continues to contribute until he’s 65 (which equals 34 years of saving).
Assuming a flat 8% annual growth rate for both until age 65, who has more money in their retirement account when they hit age 65?
Most people get the answer right (Yes, it is X 🙂) as they begin with the assumption that this is a “trick question” even though the intuitive answer seems to be Y, as he contributes WAY more (24 more years) than X.
Only when we do the math it becomes fully evident to us that we don’t grasp the concept of compounding intuitively. Let’s start right there - with the concept of compounding…
[*] I'm not a financial advisor. This is not financial advice.
Table of Contents
Compound Interest
Here is my favorite quote about compounding:
“The first rule of compounding: Never interrupt it unnecessarily.”
Most of us learn about compound interest in school. Many students memorize the formula and use it to get right answers and good grades. But, they don’t truly understand it. They don’t know where or how to use it in real life.
The exponent in the formula for compound interest is time - not the rate of return. Therefore, the first rule of compounding is to never interrupt it.
But, what does that mean?
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