Wednesday, July 9, 2008

Turn 1 cent into 5 million dollars in 30 days. Here's how.

Here's a math problem. How can you turn 1 penny into $5 million dollars in 30 days? It's rather easy.

The answer is simple and can tell you a how most fire departments waste money when they finance their new fire truck.

First, let's turn that penny into a cool 5 mil.

I'll give you 1 penny the first day, the next day I'll give you 2 pennies, the third day I'll give you 4 pennies. I'll continue to double the previous day's gift each day for 30 days.

On day 30, I'll give you $5,368,709.12!

So, will you take that deal? (P.S., send me an email to and I'll send you the math so you can double check).

You probably would like that deal.

You are benefiting from a principle called compounding. Each day, your number increases based on the previous day's number. As we see from our 1 penny to $5 million example, it can lead to some dramatic calculations.

So how does this cost fire departments a lot of money?

Bankers play a reverse game of this when they loan you money. Instead of starting small and increasing each day, they give you a large amount of money upfront and start compounding interest until you pay off your new truck.

So, instead of starting small (the 2nd day, you only get 2 cents above), the bank charges a large amount of interest at the beginning. It does get smaller but you spend a lot upfront.

How does my fire department not get caught?

Well, the biggest cost of compounding is time.

In our penny to $5 million example, on day 15 (halfway) , I would only pay you $163.84. Not bad, but a far cry from $5 million.

When you borrow money, the reverse is true. If you borrow for a shorter amount of time, you'll pay dramatically less interest.

The key is to find the balance (as I mentioned in last week's column) of an affordable payment and paying the least amount of interest.

Stay safe!

John R. Hill
Apparatus Budgeting Consultant
ENVIZION Financial

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