**Watch on YouTube:** Investing in Dog Years

Matthew talking about the power of compounding. To make it easy, we think of it like dog years and use doubling cycles. If you know your money doubles every 8 years (for example), then all you have to do is figure out how many 8 year cycles you have left and double your money that many times. No more interest calculations required – yippee!

Here’s also a link to my earlier post on Power of Compounding – The Doubling Cycle.

FYI. The book we talked about that I am reading is The Power of the Dog by Don Winslow. It’s a crime/action novel about the Mexican drug cartels. Kinda similar to Michael Connelly’s Harry Bosch series.

Subscribe to our A in Finance YouTube channel too.

**Video Transcript:**

Hi! Welcome Back. This is Matthew from A in Finance.

Last week we talked about buying a Ferrari and how it only makes you “feel” rich, but doesn’t actually “make” you rich. We also talked about how, if you invested your money instead of buying that Ferrari, you would have a lot more money in a few years. So my dad tells me to always think twice before you buy a car, a Rolex, or some other big purchase.

My dad tells me that it’s just like a story in a book he is reading called The Power of the Dog, which is about the Mexican drug cartels, so it’s not appropriate for kids. He tells me that he’ll tell me anyways, just as long as I don’t tell my mom. Ha ha. Just kidding.

Anyways, he starts telling me about a chapter he just read. He tells me that it’s about two women going on a shopping trip to New York. One woman was buying all sorts of jewelry at Tiffany’s and expensive clothes on 5^{th} Avenue. While the other one wasn’t buying anything at all.

So she says to her friend, “Buy something. Stop being so cheap.” Her response was, “I’m not cheap. I’m conservative.” Because in her mind, a thousand dollars is not just a thousand dollars to her. It’s the interest on the thousand dollars invested over the course of, say, twenty years. It’s an apartment in Paris when she retires. So she doesn’t spend money loosely, because she wants her money out there, working for her.

Then my dad asks me, “So do you know what they are talking about, you know, the interest on the interest?”

I say, “Yes, isn’t that the power of compounding you told me about? It’s one of your blog posts that you *made* me read like *five* times.”

My dad says, “yeah, well, that’s because I think the power of compounding is one of the most important financial concepts. It’s the engine that turns a thousand dollars into a million dollars.”

Anyways, so the power of compounding is where your investments grow faster and faster because they earn interest on the interest they earned the prior years.

For example, if you started out investing $1,000 dollars and got 9% interest, you would earn $90 interest after the first year.

In year 2, you would earn another $90 on the original $1,000 dollars AND also $8.10 on the $90 of interest you earned in Year 1. In Year 3, you would earn $90 on the original thousand AND earn $8.93 on the $98.10 interest you earned in the earlier years. And so on. So that $1,000 turns into $2,000, $10,000 or more the longer you have it invested. And that’s the power of compounding.

But calculating interest is complicated, so he taught me an easy way to figure it out. “Kind of like dog years,” he says. “Do you know what dog years are?,” he asks me.

I say, “Yeah, like I’m born in the year of the dog.”

Then my dad laughs and says, “No. That’s the Chinese zodiac. When people talk about dog years, they are talking about how to convert a dog’s age into a human’s age because dogs only live like 10 years, whereas humans live until we are 70 years old on average. So people like to say for every 1 year a dog lives, it’s like he is 7 human years old.”

“Oh,” I say. “That’s pretty cool.”

“Yeah, what I’m going to teach you is similar to that. We’re just trying to figure out an easy converter for interest that’s just like dog years.” Then he asks me, “You know how to multiply by 2, right?”

I say, “Yes, of course. Everybody knows how to multiply by 2.”

“Good,” he says. “Well, this is just as easy. It’s what I call your *doubling cycle*. If you know your doubling cycle, then you won’t ever need to calculate your interest.”

And this is how it works.

First, there is something called “the rule of 72”. If you divide 72 by your average rate of return (what we’ve been calling your interest rate), then it tells you how many years it takes to double your money. For example, if your average return is 9%, we divide 72 by 9 which equals 8. So it means that your money will double every 8 years. * *Now you don’t need to calculate your 9% interest every year. That’s complicated. Instead, you just have to think in 8 years, my $1,000 will be $2,000. Just multiply by 2. That’s easy.

So that 8 years in the example is what my dad calls your “doubling cycle.” Like dog years. Every 8 years, your money doubles. So how does that work with more doubling cycles?

For 1 doubling cycle, your money gets multiplied by 2.

For 2 doubling cycles, it gets multiplied by 2 and times another 2. 2 times 2 is 4. So it’s now 4x your money. For 3 cycles, it’s 2 times 2 times 2. Three twos, which is 8 times your money. For 4 cycles, it’s 2 times 2 times 2 times 2. Four twos, or 16 times your money. And for 7 cycles, it’s 2 times 2 times 2 times 2 times 2 times 2 times 2. Seven twos, or 128 times your money. If you know a little but about exponents, well that’s what this is. My dad says it’s two to the power for whatever doubling cycle you use. So for 7 doubling cycles it’s just 2 to the 7^{th} power. But I just remember that it’s 2 times 2 times 2 times, etc. however many doubling cycles I’m on.

Now because of the power of compounding, it’s not just your original investment that doubles, but all of your interest that you earn every year that doubles. __ __You see it’s not just a straight line. It’s an accelerating upward curve. My dad says the technical term is “exponential growth.” I just call it a “hockey stick”.

Well, I’m 9 years old, so I have 56 years before I retire at age 65. 56 divided by 8 is 7 doubling cycles. So if I had some spare money I could be looking at that multiple. What if I had Ferrari money? That $240,000 would become over $30 million dollars.

Well, I don’t have Ferrari money. But what if I had a more realistic amount, say $10,000. Well, with that, I would be a millionaire.

So the lesson is that, you should think twice before splurging on a fancy car or a gold bath tub like Mike Tyson did. Because it’s not really the “today” money that you are giving up, but it’s actually the “tomorrow” money that you are losing out on. And “tomorrow” money can become enormous.

So figure out your doubling cycle and use it like your personal investing dog years. Then it’s easy to see what you’re trading off in the future for the purchases you make today.

Anyways, thanks for watching. Hoped you enjoyed it and learned something. Please subscribe to our A in Finance YouTube channel and like us on Facebook. And look out for another video next week. Thanks. Bye bye.

Good article on The Motley Fool about important investing concepts to teach your kids. Top one in the article is the power of compounding which is what our Dog Years is about.

http://www.fool.com/investing/2016/06/13/how-to-teach-kids-about-investing-3-ways-to-get-st.aspx