What is Compounding?

HYIP investors often talk about compounding.  Certain investment programs offer automatic compounding as an option.  In this article, I will first explain how compounding works.  Then, we’ll get into a number of variations of the basic concept.  These will include:

Full and partial compounding
Effect of interest rate on compounding
Effect of time on compounding
Examples of current online programs with a compounding option
Compounding on your own

This is a lot of ground to cover and it will be necessary to break this article up into a number of parts in order to do it.

OK, let’s begin…

First of all, what is compounding?  Simply stated, compounding means that, every time you have interest earnings, you reinvest some or all of them — adding them to your principal.  Thus, as time goes on, your principal grows and, with every earning cycle, the interest that you receive likewise grows.

OK, as a simple example of compounding, let’s assume an investment of $100 and a daily interest rate of 5% (which is quite high) and that we’ll compound ALL of our interest earnings (100% compounding).  Here’s a table of how our principal will grow during a 30 day period…

100% Compounding
Day Principal Interest Withdraw
$100.00 $5.00 $0.00
1 $105.00 $5.25 $0.00
2 $110.25 $5.51 $0.00
3 $115.76 $5.79 $0.00
4 $121.55 $6.08 $0.00
5 $127.63 $6.38 $0.00
6 $134.01 $6.70 $0.00
7 $140.71 $7.04 $0.00
8 $147.75 $7.39 $0.00
9 $155.13 $7.76 $0.00
10 $162.89 $8.14 $0.00
11 $171.03 $8.55 $0.00
12 $179.59 $8.98 $0.00
13 $188.56 $9.43 $0.00
14 $197.99 $9.90 $0.00
15 $207.89 $10.39 $0.00
16 $218.29 $10.91 $0.00
17 $229.20 $11.46 $0.00
18 $240.66 $12.03 $0.00
19 $252.70 $12.63 $0.00
20 $265.33 $13.27 $0.00
21 $278.60 $13.93 $0.00
22 $292.53 $14.63 $0.00
23 $307.15 $15.36 $0.00
24 $322.51 $16.13 $0.00
25 $338.64 $16.93 $0.00
26 $355.57 $17.78 $0.00
27 $373.35 $18.67 $0.00
28 $392.01 $19.60 $0.00
29 $411.61 $20.58 $0.00
30 $432.19 $21.61 $0.00

The good news is that, in a month’s time, your principal has grown by over four times — from $100 to $432.  Likewise, your daily interest has grown from $5 to over $21.  Of course, you haven’t put any money in your pocket yet.  But, this sure looks nice on paper.

If we had continued this spreadsheet longer to, say, a term of 110 days, some of the key entries would be:

100% Compounding
Day Principal Interest Withdraw
$100.00 $5.00 $0.00
30 $432.19 $21.61 $0.00
60 $1,867.92 $93.40 $0.00
90 $8,073.04 $403.65 $0.00
110 $21,420.17 $1,071.01

So, remarkably, after 110 days, your principal has grown from a mere $100 to over $21,000 and you are earning over $1,000 dollars per day in interest.  This, of course, is the “Miracle” that the HYIP investor dreams about.  When he hears of a program that offers automatic compounding, he optimistically figures that he will let his investment compound for a few months and then, after that, he will simply withdraw his daily interest.  Well, this really look good on paper.  But, what’s wrong with this picture?  Here are a few things:

The program might not survive for the 110 day investment term and you will lose everything!  This is the “Monster” lurking behind the scenes in every automated compounding system.
This interest rate is excessively high.  There is only a very slim chance that a company paying such a rate can survive.

Partial Compounding.

To get around the first problem, an investor might decide to only compound, say, 50% of his interest earnings and withdraw the other 50%.  This is a sort of safety net in case the program should die before it reaches the term of 110 days that we have chosen here.  Let’s take a look at what happens in this case for the first 30 days.

50% Compounding
Day Principal Interest Withdraw
$100.00 $5.00 $2.50
1 $102.50 $5.13 $2.56
2 $105.06 $5.25 $2.63
3 $107.69 $5.38 $2.69
4 $110.38 $5.52 $2.76
5 $113.14 $5.66 $2.83
6 $115.97 $5.80 $2.90
7 $118.87 $5.94 $2.97
8 $121.84 $6.09 $3.05
9 $124.89 $6.24 $3.12
10 $128.01 $6.40 $3.20
11 $131.21 $6.56 $3.28
12 $134.49 $6.72 $3.36
13 $137.85 $6.89 $3.45
14 $141.30 $7.06 $3.53
15 $144.83 $7.24 $3.62
16 $148.45 $7.42 $3.71
17 $152.16 $7.61 $3.80
18 $155.97 $7.80 $3.90
19 $159.87 $7.99 $4.00
20 $163.86 $8.19 $4.10
21 $167.96 $8.40 $4.20
22 $172.16 $8.61 $4.30
23 $176.46 $8.82 $4.41
24 $180.87 $9.04 $4.52
25 $185.39 $9.27 $4.63
26 $190.03 $9.50 $4.75
27 $194.78 $9.74 $4.87
28 $199.65 $9.98 $4.99
29 $204.64 $10.23 $5.12
30 $209.76 $10.49 $5.24

This is quite a different story from the case with 100% compounding.  Now, your principal has doubled and you are earning around $10 per day, half of which you are withdrawing and half of which you are reinvesting.  If you had added up all the withdrawals, the total would come to $115.  So, you would have broken even in less than one month.  To compare this to the case with 100% compounding, your principal only increased by half as much.  However, you are safe since you recovered your initial investment.

Now, let’s continue the table as we did for the 100% compounding case, again only looking at key values.

50% Compounding
Day Principal Interest Withdraw
$100.00 $5.00 $2.50
30 $209.76 $10.49 $5.24
60 $439.98 $22.00 $11.00
90 $922.89 $46.14 $23.07
110 $1,512.26 $75.61

Now it is possible to see some major differences occurring.  Our principal has grown to around $1,500 whereas, for the case of 100% compounding, it had grown to over $21,000.  Similarly, the daily interest earnings are now around $75 whereas, in the case of 100% compounding, they had grown to around $1,000 per day.  So, by compounding half of your interest earnings, you reduce both your principal and interest earnings by much much more.  So, if a person is aware of the possible “Miracle” that can occur when you compound most or all of your earnings, it is very very tempting to ignore the “Monster” lurking in the background that could result in your losing everything.

The question, of course, is, “Which is the better choice?”  Is it better to compound 100% in hopes that a program will survive long enough to pay you a very respectable passive income later on or is it best to compound 50% — or some other partial amount — to protect yourself from the possible premature failure of a program?

This is the classic dilemma associated with HYIP investing.  How much risk do you want to take in hopes of larger future gain?  This is a very individual thing.  We offered some suggestions on this in a previous HYIP Insights article that you can read here.

In the next part of this article we will discuss the effects of interest rates and time on compounding.  Please stand by.

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