Crash Course - Chapter 4 - Compounding is the Problem

The purpose of this mini-presentation to help you understand the power of compounding. If something, such as a population, oil demand, a money supply, anything, steadily increases in size as a proportion of its current size, you get a graph that looks like this - a hockey stick. Said more simply, if something is increasing over time on a percentage basis, it is growing exponentially. Using an example drawn from a magnificent paper by Dr. Albert Bartlett, let me illustrate the power of compounding to you. Suppose I had a magic eye dropper and I placed a single drop of water in the middle of your left hand. The magic part is that this drop of water is going to double in size every minute. At first nothing seems to be happening, but by the end of a minute, that tiny drop is now the size of two tiny drops. After another minute, you now have a little pool of water that is slightly smaller in diameter than a dime sitting in your hand. After six minutes, you now have a blob of water that would just fill a thimble. Now suppose we take our magic eye dropper to Fenway Park, and, right at 12:00 p.m. in the afternoon, we place a magic drop way down there on the pitcher’s mound. To make this really interesting, suppose that the park is watertight and that you are handcuffed to one of the very highest bleacher seats. My question to you is this, “How long do you have to escape from the handcuffs?” Days? Weeks? Months? Years? How long would that take? I’ll give you a few seconds to think about it. The answer is, you have until 12:49 on that same day to figure out how you are going to get out of those handcuffs. In less than 50 minutes, our modest little drop of water has managed to completely fill Fenway Park. Now let me ask you this at what time of the day would Fenway Park still be 93% empty space, and how many of you would realize the severity of your predicament? Any gueeses? The answer is 12:44. If you were squirming in your bleacher seat waiting for help to arrive, by the time the field is covered with less than 5 feet of water, you would now have less than 5 minutes left to get free. And that, right there, illustrates one of the key features of compound growth… the one thing I want you take away from all of this. With exponential functions, the action really only heats up in the last few moments. We sat in our seats for 44 minutes and nothing much seemed to be happening, and then in five minutes – bang! – the whole place was full. This example was loosely based on a wonderful paper by Dr. Albert Bartlett that clearly and cleanly describes this process of compounding, which you can find in our Essential Reading section. Dr. Bartlett said, “The greatest shortcoming of the human race is the inability to understand the exponential function.” And he’s absolutely right. With this understanding, you’ll begin to understand the urgency I feel - there´s simply not a lot of maneuvering room once you hop on the vertical portion of a compound graph. Time gets short. This makes compounding the first Key Concept of the Crash Course. Now, what does all of this have to do with money and the economy and your future? I can’t wait to tell you. Let´s go find out.