Given a choice, which of the following would you prefer?
a) A penny that doubles every day for 30 days.
Most people would likely choose $1,000,000. The penny that doubles every day for thirty days, however, would result in more than ten times that amount – or $10.7 million to be exact. This simple question is a perfect, if somewhat extreme, illustration of the power of compounding.
We can do better
The principle of compounding is central to growing wealth over the long term. Alas, this subject is rarely taught effectively to American students. Perhaps it's no surprise that many of them, later in their lives, will struggle with debt and an inability to save.
Too much of our schools' curriculums are dedicated to abstract topics that are infinitely less useful than compounding and the notion of opportunity cost. The latter term, defined simply, is what one would give up by choosing an alternative option.
The weaknesses of our current system became abundantly clear to me when I saw my eighth grade son doing his algebra homework last year. Algebra is actually a very difficult subject for students to grasp, yet for some reason we place it at the beginning of the sequence of math courses. Unfortunately, the complexity of Algebra often dissuades students from taking additional math classes later in their course work. And those later courses – like statistics and basic finance – are often a lot more practical for the future.
Far too often, students won't even be exposed to the principles of compounding and opportunity cost until they go to college. And even then, they don't actually learn them very well. I bet many adults would struggle to clearly explain these powerful concepts.
A way forward
I believe strongly that education should be about applying knowledge toward achieving a specific objective. In this case, these two concepts could help each of us achieve financial independence. Below, I'll show you precisely how that might be accomplished for young people.
Here's a possible objective that all students might strive to achieve. What if we asked every child to try and save $100,000? Sure, it sounds crazy, but I think we might also agree that it's possible.
Our children should always have bold, audacious goals. And far too many adults, I might add, haven't saved anything close to $100,000. Why not get our kids started early? Remember, anything they end up saving would still be better than nothing.
Obviously, it won't be easy for them to save $100,000. But the earlier one starts saving, the more attainable the goal will become. And once you reach six figures, the magical $1,000,000 mark isn't all that far to go. Whether or not Einstein actually said that "compound interest is the 8th wonder of the world," there's still an extremely valuable insight from that statement. Those who understand compounding are destined to collect interest over the course of their lives. Those who do not understand it will be paying it, sadly.
One of the biggest downfalls for people trying to save is that they don't fully understand the opportunity costs associated with spending today versus investing for tomorrow. It's understandable, of course. What kid doesn't want a new pair of Kevin Durant sneakers? Or what about those Venti Frappuccinos several times a week? As the comedian Gary Gulman has observed, "it only adds up if you add it up!"
Somehow, we've created generations of people who have been encouraged to ring up debt and pay compound interest instead of collecting it. We choose to finance depreciating assets like automobiles in order to make them seem more affordable. We ring up unsustainable debt for high-priced degrees from institutions that seem more like country clubs than rigorous institutions of higher learning. Is it any wonder that student debt is now a $1 trillion problem in America?
You begin this way
We must do better. That's why encouraging young people to try and save $100,000 is such a worthy goal. In order to hit the target, they'll need to ask difficult questions. Do I want to spend my money on fast food and the latest gadgets? Would a public college make more sense than a private one? How can I invest my savings to make it grow more quickly?
Here's one invaluable lesson they'll learn from this endeavor. If you spend $1,600 this year – assuming you could earn 9% per year on an investment -- it's costing you $50,000 forty years from now. A penny spent today is worth a ton of lost pennies later, as I'm sure someone famous has said previously.
So why not take up my challenge and encourage a young person (or two) to try and save $100,000. Help them set up a plan to achieve that audacious goal. The very act of trying will change the way they think about everything relating to personal finances. And let's say they try, but miss the target by half. Saving $50,000 is still a lot more than millions of Americans have managed to save over the course of their lifetimes.