A frequently asked question is: What is the difference between exponential growth and compounded growth? The simple answer is: there is no difference. Compound growth is a term usually used in finance to describe geometric or exponential growth in interest or dividends. Compounding is not linear growth (i.e. 1,2,3,4,5,6,7) but geometric or exponential growth (i.e. 1,2,4,8,16,32,64).
Exponential growth is a universal principle and can be used to describe any increase that is proportional to what is already there. In other words, even though the growth rate remains constant, each successive period of time the amount of growth is greater than the previous period. The concept is very powerful because the results have great implications. Important studies in exponential growth are constantly being done in areas such as world population growth or the spread of bacteria.
Example of Exponential Growth
There are many examples of exponential growth but here is a simple illustration. What if you agreed to give me 1 penny today and to double the amount you give me each day for 30 days. You might think that’s not to bad, I can probably do that. So the first day you give me .01, the next day .02, the next day .04, the next day .08, and so forth. This would seem to be achieved with relative ease at first. But on day 15 you would be giving me $164, by day 20, $5243, and by day 30, over $5.3 million dollars!
Exponential Growth Model
The above example dramatically illustrates the power of compounding because the growth rate is 100% per time period. But the principle works the same at lower growth rates, it just takes more time periods. This makes time the most important aspect of reaping the benefits of exponential growth.
In finance and investing, time is the key concept to benefit from interest compounding or dividend growth compounding. Use time and the power of exponential growth to your advantage. This means being patient and/or not giving up too soon because the majority of the benefits are realized in the later time periods. Investors who understand the exponential growth model will have a much better chance of building wealth to meet their goals than those who don’t.
| AAAMP Blog by Ken Faulkenberry | |
|
Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
 |
{ 1 trackback }