Undercapitalization

finance a la shmoop- what is compounding value or compounding interest? ah the

power of compounding. it makes trees stronger pollution more feral and the

rich well richer. how so well let's start with compounds kissing

cousin with six toes, arithmetic compounding. right so the first was [feet with six toes pictured]

really geometric compounding now we're talking about arithmetic compounding. if

you invest a thousand bucks in a ten-year bond that pays 6% of a year in

interest, the dough comes back to you in a pattern that looks like this - like

every six months they pay thirty bucks and it's $60 a year, got it? nice. you get

the total of sixteen hundred bucks back from your investment and the cash that

came back to you you know came in small parts all along the way, until you got [list of yearly returns]

about two thirds of it or sixty percent at the end right? if you just spent that

money and collected your thousand bucks at the end that's it. okay so that's

arithmetic compounding/ the money comes to you if you don't reinvest it.

ding-ding-ding that's the key here and you just go buy burgers. okay so now

let's look at what six percent compounded looks like over the same

10-year period .well at the end of year one it's a thousand sixty bucks and note

we're only gonna compound it annually we probably should do the semi-annually but [list of yearly compounds]

we'd confuse you even more so don't do that. but then you essentially reinvest

that money and you get another six percent compounded on that thousand

sixty , instead of six percent compounded against the original thousand. so by the

end of year two you'll have a thousand one hundred twenty three sixty. and by

the end of year ten you'll have one thousand seven hundred and ninety

dollars and eighty-five cents. so why do you make so much more money when you

compound interest versus getting 30 bucks twice a year like you would in

this bond example? go and find burgers with it? yeah .you don't want to do that

well essentially what's happening is that you're delaying your gratification [man in a drive through window]

of getting that sweet sweet cash or getting liquid whatever you want to call

it. by reinvesting your gains year after year after year. so do you have that sort

of self-control? do you need the cash yeah that's the question if you for

example have trouble making it home from your local pizza spot with the pie

in tact well then compound interest keeping the discipline to not spend the [man eats pizza while driving]

money today and wait for the happiness tomorrow well when that may not be for

you. sorry