The Effects of Compounding

Although there may not be any profound moral distinction between spenders and savers, savers have

A T T I T U D E S A N D A P T I T U D E S
one key tactical advantage over spenders. They tend to be on the winning side of compounding. Compounding is the most important financial tool you can use. In short, it is the progressive effect that earning interest (or, on the other hand, paying
interest) has over a long period of time. It’s like putting two rabbits in a room and coming back to find that they’ve multiplied to 20. The longer you’re out of the room, the more rabbits you get. Money works the same way. If you put it in the right place and give it time, it will multiply.

For the saver, incremental growth is the key to accumulating wealth. Usually, the effect of compound earnings over 20 or 30 years of steady investment will mean as much if not more than any individual investment decision.

For the spender, the flip-side advice is: Avoid debt. Compounding can work against you as steadily as it can for you. The paths to many personal bankruptcies are paved with finance charges. And financing finance charges. If you’re moving balances from credit card to credit card...or to equity lines or other loans...stop financing new purchases. Take the credit cards out of your wallet. If you don’t trust yourself even then, cancel all but one or two accounts or pay cash. If you’re able to put away some true savings (after you’ve paid off your consumer debt) at the end of each month, congratulations you can skip the next few pages.

If you don’t have enough money to pay your bills at the end of each month, or if you want to save more than you are now, there are only two ways to fix your problem: make more or spend less. Earning more is tough and usually relies on external factors (the job market or investment market). Spending less is the best way to improve your financial health. First, ask yourself: Where does all of your money go?

Answering that question takes a bit of work, but it’s a key step to building family wealth.

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