Mellody Hobson talks about the power of compounding on today’s “Money Mondays” segment.
I’m sure TJMS listeners know about the power of compounding. It’s how you make money on investments over time—where you earn interest on your interest. When it comes to achieving long-term financial goals like a secure retirement, compounding is the key. There’s even a popular urban legend (that may or may not be true) that Einstein called compounding, “the most powerful force in the universe.”
Think about it this way: If you had a penny and doubled it every day for a week, you’d have 64 cents. But if you took that same penny and doubled it every day for a month, you’d have over ten million dollars.
I can show you the math. It starts with one penny. You don’t need to be Einstein to realize that harnessing the power of compounding is the way to earn money in the stock market.
Okay, so what’s the best way to harness that power?
First of all, compounding is about getting started early and investing regularly. All too often, people try to time the market. And now, with the stock market at record levels, people may be tempted to cash out in the effort to “sell high.” Don’t do it.
The greatest investment minds have proved over and over that timing the market doesn’t work. I don’t try to time the market, and I know a thing or two about investing. Warren Buffett doesn’t try to time the market, and he’s arguably the most respected (and wealthiest) investor of all time. So it’s just plain crazy when the average investor thinks he or she can time the market with any measure of success. What pays off is time in the market, not timing the market.
The average investor can take advantage of compounding by dollar cost averaging—investing the same amount of money at a regular schedule, regardless of the share price. Let me give you an example about how this works.