Heres a fun quiz, Suppose there is a bacterium in a test tube. This bacterium splits itself in two, every second. So in 1 second there are two bacteria. In two seconds there are four and so on. Now it takes the bacteria 10,000 years to fill one fourth the test tube. How many seconds does it take to fill the entire test tube?
I know most of you have come across this question in some form or the other before, but for those who couldn't figure it out it is "2" seconds. The answer 2 seconds is true if the bacteria took 1 billion years or 1 year to fill one fourth the test tube.
This post is on one of my favorite topics, Exponential Growth. Exponential Growth is all around us. Let me give you a few examples
Population - There were approximately 1 billion people in the year 1750. It took 175 years to add a billion people i.e. 1925 the population was 2 billion. It took 35 years after that for the next billion. 15 years after that for the next billion. 11 years for the next, and now every 10 years after that we are adding a billion people on Earth, much like the bacteria in the test tube. If we were to make a hypothetical extrapolation of this growth, given enough time there will be a stage when we will add a billion people every year, then every month, every day, every second.
Computing Power - This is one phenomenon we can relate to. Every year computer speeds/memory gets faster/bigger. The computing power of your cellphone today is greater than the computing power of all computers combined in 1950. I remember my first computer having a space of 200MB, now we have virtually Tera Bytes of storage space available on the cloud. It is not science fiction if I say 10 years down the line your phone will have a Tera Byte capacity or even more.
Inflation - The prices of basic goods grows on average at an exponential rate. We all heard stories from our grand parents where they were earning a fraction of what we do and food costs was fraction of what it is today.
I want you to get a feel for Exponential Growth, wrap your heads around that fact that 10,000 years of bacterial growth is replicated in a mere second, centuries of research in computing is made obsolete in a decade.
I want to now bring this concept of Exponential Growth to personal finance. Before I start, what differentiates a wealthy person from a poor one? In my opinion it is how their wealth was created. Was it through an exponential process or was it linear.
Typical middle class or poor families earn their income primarily from their salary. Salary by definition cannot have exponential growth. Think about it, on a company's financials you are just an entry in the income statement, under operating expenses. The primary goal of a company is to make profit which is done either by increasing revenue or decreasing expenses i.e. keeping you salary as tiny as possible without affecting the revenue aspect.
For your salary to have exponential growth you have to constantly perform in your job. You have to get promoted yearly, you have to take on bigger roles, manage larger groups of people, eventually maxing out your salary at the CEO level. I can bet there is no company in the world where if you perform exactly the same as you do now, every year for the rest of your career your salary will be increased exponentially. The reality is if you don't improve constantly either your salary stays the same, or worse you will be fired and replaced by a much younger and cheaper resource.
My friends, you will never be wealthy from your job, that's a fact. You might give me counter examples of sportsperson, bankers, CEO's who have made millions in their profession. I am not denying that, I am also not discouraging you from giving your best to your work. My whole argument is, a profession will never provide Exponential Growth to your income which really creates wealth. So what does?
Investments. Your investments give you Exponential Growth. A house, a fixed deposit, stocks, bonds, your company. These will make you wealthy, not your salary.
Here is an example to illustrate my point.
Once upon a time, there were two friends Adam and Zack. At the age of 25, both joined the same company with a starting salary of $60,000. Every two years, they got an increment of 10% in their salary. Both wanted to be wealthy and both worked till they were 60.
Adam thought the surest way to be rich is to save 100% of his income till he retires. So every year, he would receive his paycheck, he would then put this money in a safe, and not spend a single cent or earn a single cent on it.
Zack on the other hand was different. He wanted to be rich too but he knew the surest way to be rich is for his income to have Exponential Growth. Every year he would save 20% of his salary and spend the rest. He would burn through 80% of his salary carefree watching movies, buying cars, travelling, much to the envy of Adam. Zack would put his 20% saving in an investment that earned 10% annually.
10 years into their career, at the age of 35 Adam was worth $830,000 while Zack was worth $260,000. At the age of 45, Adam has $2 million in the safe while Zack's investments were worth $1 million. When both of them retired at 60, Adam saved $5.4 million while Zack's saved $5.8 million.
Adam is perplexed, how could this be. How could he have had 4 times the money at one point in his career as Zack did and end up having the same amount of money as him, even though Zack spent 80% of his money every year. But the story got worse, at 70 Adam was still worth $5.4 million, while Zack's investment was $15 million. 10 years later, on their death beds, Adam passed down $5.4 million to his family, while Zack's family inherited $39 million.
Lets pause for a moment. I want you to ignore the oversimplification of this example, to ignore the hypothetical returns of Zack's investment. I want the reader to get the essence of the story, just like the bacteria in the test tube, Zack's wealth took a long time to reach Adam's wealth. But once it did, thanks to the power of exponential growth, his wealth exploded. That is what it is, a nuclear explosion (Exponential Growth in energy). Zack's wealth blew past Adam's hard earned salary based wealth. The total investment Zack made was a measly $1 million, which given enough time grew to $39 million.
No matter how hard we try, we are genetically not wired to visualize Exponential Growth. Nature has very few examples that we can relate to. Here's a test, if Zack's grand daughter inherited the $39 million at the age of 25 and never touched it while the investment continued to earn 10% annually, how much do you think it was worth when she turned 80? Any guesses ? (answer at the end of the post)
In conclusion, I hope I have driven home the point that one should not depend on their salary to become wealthy but should save and more importantly invest and make it grow Exponentially.
The more you save, the more time you give, the bigger your investment. So lets stop thinking linearly and start thinking Exponentially.
Answer: $ 7.3 Billion (yes that a billion with a "B" on an investment of $1 million)
I know most of you have come across this question in some form or the other before, but for those who couldn't figure it out it is "2" seconds. The answer 2 seconds is true if the bacteria took 1 billion years or 1 year to fill one fourth the test tube.
This post is on one of my favorite topics, Exponential Growth. Exponential Growth is all around us. Let me give you a few examples
Population - There were approximately 1 billion people in the year 1750. It took 175 years to add a billion people i.e. 1925 the population was 2 billion. It took 35 years after that for the next billion. 15 years after that for the next billion. 11 years for the next, and now every 10 years after that we are adding a billion people on Earth, much like the bacteria in the test tube. If we were to make a hypothetical extrapolation of this growth, given enough time there will be a stage when we will add a billion people every year, then every month, every day, every second.
Computing Power - This is one phenomenon we can relate to. Every year computer speeds/memory gets faster/bigger. The computing power of your cellphone today is greater than the computing power of all computers combined in 1950. I remember my first computer having a space of 200MB, now we have virtually Tera Bytes of storage space available on the cloud. It is not science fiction if I say 10 years down the line your phone will have a Tera Byte capacity or even more.
Inflation - The prices of basic goods grows on average at an exponential rate. We all heard stories from our grand parents where they were earning a fraction of what we do and food costs was fraction of what it is today.
I want you to get a feel for Exponential Growth, wrap your heads around that fact that 10,000 years of bacterial growth is replicated in a mere second, centuries of research in computing is made obsolete in a decade.
I want to now bring this concept of Exponential Growth to personal finance. Before I start, what differentiates a wealthy person from a poor one? In my opinion it is how their wealth was created. Was it through an exponential process or was it linear.
Typical middle class or poor families earn their income primarily from their salary. Salary by definition cannot have exponential growth. Think about it, on a company's financials you are just an entry in the income statement, under operating expenses. The primary goal of a company is to make profit which is done either by increasing revenue or decreasing expenses i.e. keeping you salary as tiny as possible without affecting the revenue aspect.
For your salary to have exponential growth you have to constantly perform in your job. You have to get promoted yearly, you have to take on bigger roles, manage larger groups of people, eventually maxing out your salary at the CEO level. I can bet there is no company in the world where if you perform exactly the same as you do now, every year for the rest of your career your salary will be increased exponentially. The reality is if you don't improve constantly either your salary stays the same, or worse you will be fired and replaced by a much younger and cheaper resource.
My friends, you will never be wealthy from your job, that's a fact. You might give me counter examples of sportsperson, bankers, CEO's who have made millions in their profession. I am not denying that, I am also not discouraging you from giving your best to your work. My whole argument is, a profession will never provide Exponential Growth to your income which really creates wealth. So what does?
Investments. Your investments give you Exponential Growth. A house, a fixed deposit, stocks, bonds, your company. These will make you wealthy, not your salary.
Here is an example to illustrate my point.
Once upon a time, there were two friends Adam and Zack. At the age of 25, both joined the same company with a starting salary of $60,000. Every two years, they got an increment of 10% in their salary. Both wanted to be wealthy and both worked till they were 60.
Adam thought the surest way to be rich is to save 100% of his income till he retires. So every year, he would receive his paycheck, he would then put this money in a safe, and not spend a single cent or earn a single cent on it.
Zack on the other hand was different. He wanted to be rich too but he knew the surest way to be rich is for his income to have Exponential Growth. Every year he would save 20% of his salary and spend the rest. He would burn through 80% of his salary carefree watching movies, buying cars, travelling, much to the envy of Adam. Zack would put his 20% saving in an investment that earned 10% annually.
10 years into their career, at the age of 35 Adam was worth $830,000 while Zack was worth $260,000. At the age of 45, Adam has $2 million in the safe while Zack's investments were worth $1 million. When both of them retired at 60, Adam saved $5.4 million while Zack's saved $5.8 million.
Adam is perplexed, how could this be. How could he have had 4 times the money at one point in his career as Zack did and end up having the same amount of money as him, even though Zack spent 80% of his money every year. But the story got worse, at 70 Adam was still worth $5.4 million, while Zack's investment was $15 million. 10 years later, on their death beds, Adam passed down $5.4 million to his family, while Zack's family inherited $39 million.
Lets pause for a moment. I want you to ignore the oversimplification of this example, to ignore the hypothetical returns of Zack's investment. I want the reader to get the essence of the story, just like the bacteria in the test tube, Zack's wealth took a long time to reach Adam's wealth. But once it did, thanks to the power of exponential growth, his wealth exploded. That is what it is, a nuclear explosion (Exponential Growth in energy). Zack's wealth blew past Adam's hard earned salary based wealth. The total investment Zack made was a measly $1 million, which given enough time grew to $39 million.
No matter how hard we try, we are genetically not wired to visualize Exponential Growth. Nature has very few examples that we can relate to. Here's a test, if Zack's grand daughter inherited the $39 million at the age of 25 and never touched it while the investment continued to earn 10% annually, how much do you think it was worth when she turned 80? Any guesses ? (answer at the end of the post)
In conclusion, I hope I have driven home the point that one should not depend on their salary to become wealthy but should save and more importantly invest and make it grow Exponentially.
The more you save, the more time you give, the bigger your investment. So lets stop thinking linearly and start thinking Exponentially.
Answer: $ 7.3 Billion (yes that a billion with a "B" on an investment of $1 million)
2 comments:
Very Well written..Really nice explanation ..
Nice article. Really good read.
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