TheDripBuzz - Oct 29, 2022
It could be easier than you think, but you need to have patience
I love money! Not because of what it is, but because of what it represents: Freedom. Freedom of how to spend your time. Freedom of where to live, how to live, and how to love.
Do you love money? If answering yes gives you a foul taste, let me ask another question: Would you like to spend more time with your family, your friends, or loved ones? If so, what is stopping you? For the majority of us, myself included, the answer is "work". Five days a week, we have to get up and devote most of our time and energy to generating revenue for somebody else. In return, we get the paycheck, that we so happily allow to enslave us.
Many of us are dreaming of a way out. We buy lottery tickets and invest in stocks, property, or crypto. Or we just dream because we are too tired from work to actually do something.
But there might be hope. The field of mathematics can give us some unexpected assistance. Could it be possible to calculate our way into financial freedom?
What does financial freedom mean to you?
First, let us define "financial freedom". Many define financial freedom as enough money to never have to work again and do whatever you want for the rest of your life. That would be great! But I don't want to sit on my butt and watch Netflix for the rest of my life, or in a chair on a beach somewhere sipping long drinks in the sun. Some of the time, yeah, but not all. I still want to work (for myself), create something, and give something back.
For me, it is more about the possibility to choose, without fear of running out of money. That means little or no debt, low monthly costs (i.e. owning my own house and car instead of paying rent), and a reserve big enough that I could live off it for several years without worrying about temporary income swings. But I would like to have income. Maybe work part-time for the social aspect. Or most likely, starting my own business.
The number for financial freedom can be different for different people. But one million dollars would go a long way for most people. It would buy you a decent house in most parts of the world, leaving enough to spare for years to come while you pursue your passion. So I will use that number for these examples - but the same principles would work for different amounts.
Earning a million bucks takes time
Even the highest-paying jobs rarely offer million-dollar salaries. Which means most people would have to work several years to earn that much. According to Google,[11 the average salary in the USA in 2022 was about $54,132 per year. This means for the average American, it would take about 18,5 years to earn a million, before taxes.
Let's talk a little about compounding then. Einstein described [2] it as "The most powerful force in the universe". I think this has to do with the scalability and the exponential nature of compounding. Given enough time, you can start with one dollar, and earn a million - there are no limits.
Starting point decides how much time it takes
Below is the formula for compound interest [3]:
Personally, I like to simplify this a little, by setting n=1 and adding up 1 + r/n into a number representing the interest. 5% interest would then give 1.05, and the full formula becomes:
A = P x 1.05^t
This makes it easy to calculate on a regular calculator by simply entering P x 1.05, and then hitting the equals key the number of times you like, e.g. 10 times for 10 periods. But let's step it up a little bit, and utilize the internet to our benefit. There are several free graph tools out there, and I like desmos [4] because it is so simple (and free) to use.
Let's say we have $10,000 that we would like to invest in stocks, anticipating an average 10% yield. We enter the formula f(x)=10000 * 1.1^x. Desmos then gives us a nice chart for us to study:
So after just 48.3 years, you are officially a millionaire, congratulations!
Most of us are probably not willing to wait that long. So what can we do to speed it up? Several things actually:
Increase the starting amount
Increase the interest rate
Decrease the time of the interest period
Add more money every period
Let's try! What if we increase the principal to 100k?
This decreases the time to "just" about 24 years. It is still a long time.
But what if we increase the interest rate? Let's try 20%:
Wow! After just 12.3 years, we have reached the goal. But what if we were really good at picking stocks, and were able to gain an amazing 50% per year consistently?
5.6 years! Wow! This is really starting to look like something. So just grab your 100k in cash, brush up your stock-picking skills and let's go! No?
Unless you are Warren Buffet, you can hardly expect this type of return. And most of us don't have 100k lying around either. You could decrease the time a bit by adding monthly deposits to the mix, but I won't dig into that now. Instead, I will present you with the third option - which is decreasing the time it takes to get the given interest rate. I am of course talking about DRIP!
DRIP pays 1% per day, which takes us to a whole new level of compounding. For the sake of argument, let's leave the DRIP technicalities out of the equation, and focus on dollars and compounding. Let's also assume you hydrate once every day and do not claim.
First, let's find out how much $10 will turn into after one year:
Without compounding, with 365% interest: $46.5
With compounding, 1% per day for 365 days: $377.8
This is the power of compounding! Now we can reverse-engineer our numbers to see how many percent "interest" a year with compounding would represent without compounding:
(377.8 - 10) * 100 / 10 = 3678%
Astonishing - by compounding every day you can get more than 10x the total interest rate!
Putting this into the graph, we see the following:
So by starting with $10, you end up with a million after just over 3 years.
It is also interesting to see how it jumps from 500k to 1M in very little time, while it takes over 2 years to achieve 100k. This illustrates how starting with a bigger amount would make you able to save a lot of time. For E.g. if starting with $1000:
Or $10k:
As you can see, the result is the same, it just takes shorter or longer time to get there depending on the amount. Even starting with $1 would get you up to 1M in under 4 years!
Now, from the great world of mathematics, and back to the real world. Of course, in real life, things are a little bit different. Not that compounding doesn't work, it sure does! But there are more factors to consider. Using DRIP as an example, there are plenty of things to consider:
For this example to work, you must compound daily, every day, and never claim. This will incur quite some gas fees and is also maybe not the best strategy. Check out the tools section for a DRIP calculator where you can find the best strategy for your needs.
In DRIP, there is a max limit of 100k DRIP that can be claimed. This means that with the current price of DRIP around $5, it is not possible to reach $1M, at least not with a single wallet
There is also a compounding tax of 5%, which means the compounding effect will be slightly less than in this example
Also, three years is a long time to wait, if you're starting out with $10. It will require a lot of discipline and stamina to be able to complete such a strategy
Finally we have the DRIP price, which is the biggest party pooper. It has fallen a lot from ATH of $169.61 in January. If it continues falling, the compounding effect will be greatly reduced
So in real life, it is always best to never bet more than you can afford to lose. Then, it is important to try and have some fun along the way. Don't stress about compounding every day, you will have a great compounding effect even if compounding once every week, compared to not compounding at all. And finally, it is also ok to claim every once in a while. Maybe get that initial stake back. It is so much more enjoyable when you have the potential to earn a significant amount, without any risk compared to going all in and risking losing it all.
I hope this has shown you the power of compounding. And even if theory and practice do not always match, it can be a significant power and a great tool in your investment arsenal.
Keep calm, and DRIP on!
Sources:
Source no | Title | Link |
1 | The Average salary in the USA | |
2 | Einstein quote | |
3 | Compound formula | |
4 | Desmos graph tool |
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