This chapter contains a bit of math but we will keep it to the basics.
Exponential Growth is one of the most powerful forces of the Universe and is the underlying structure to many phenomena.
Exponential growth is everywhere
It is observed in many places in life: compounded interest of mortgages and credit card debt but also of savings, vicious and virtuous circles, feedback loops, self-fulfilled prophecies, confirmation bias. Napoleon Hill named it Hypnotic Rhythm. Conventional wisdom calls it snowball effect. A more modern term is viral.
Although not exactly the same thing, it is also called geometric progression in Maths.
Exponential growth is what brings things to the tipping point fast (a.k.a. the last straw).
Growth is what happens when change occurs in one single direction. Often change occurs in several directions and basically keeps things the way they are. Earning and spending are both changes in your bank account and they each pull the balance in opposite directions and your bank account usually remains the same over time. If earning dominates, then your bank account will grow because the sum of all changes is going in one direction. We are better acquainted with the opposite, where spending dominates, and debt is growing.
Linear growth vs. Exponential growth
Linear growth occurs when things add up. Exponential growth occurs when things are multiplied or elevated to a power.
- If you take 1 and add 2 several times, you get 1, 3, 5, 7, 9, 11, 13, 15 ...
- If you take 1 and multiply by 2 several times, you get 1, 2, 4, 8, 16, 32, 64, 128 ...
Please note the two most important characteristics of Exponential Growth
- It tends to grow a lot higher a lot faster.
- It does not seem like much at the beginning and may even stay below a linear growth, then there is a tipping point, and things go out of control.
Exponential growth is at the foundation of interest loans and credit cards and of savings, so it is imperative you understand this concept to have a healthy financial life. You don't need to necessarily get the math, but the concept of exponential growth.
Your financial survival depends on it.
Only linear growth is naturally understood by the brain
The problem is that our brain is wired to understand linear patterns so we always oversimplify reality so we can grasp what is happening but this oversimplification has a real drawback. And some people who know that will try to trick us for their lucrative benefit.
This is a fictional example of linear growth: Deposit $1000 on an account and the bank pays you 10% every month. You are smart and put that money in your piggy bank. Your piggy bank will grow as follow: $100,$200, $300, $400, $500, $600, etc. after 6 months you own $1000 in the bank and $600 in the piggy for a total of $1600.
This is pure fiction. There is no such thing as a 10% return per month. Investors were lured by Bernie Madoff with 10% a year, which is a dreamlike return. Most saving accounts merely bring 1% a year.
Now a fictional example of exponential growth: Deposit $1000 on an account and the bank pays you 10% every month. You are even smarter and put that money back in the bank account. So the bank is now paying interests on the initial deposit PLUS the interests that you kept on the account. And it grows like this:
- $1,000.00 yields $100.00 and balance becomes $1,100.00
- $1,100.00 yields $110.00 and balance becomes $1,210.00
- $1,210.00 yields $121.00 and balance becomes $1,331.00
- $1,331.00 yields $133.10 and balance becomes $1,464.10
- $1,464.10 yields $146.41 and balance becomes $1,610.51
- $1,610.51 yields $161.05 and balance becomes $1,771.56
As you can see, the same 6 months have paid an extra $171.56 for apparently no reason. That is the power of exponential growth.
The same logic happens to credit and interests on the balance due. Debt gets out control because interests is built on the borrowed amount plus the previous interests. Basically, the debtor is paying interest on interest. And that is where the real money is made by the lender.
Compounded interest is one of the most powerful forces of the Universe.
— Albert Einstein
Exponential growth's famous riddles
A wise man taught a king the game of chess. The king was very pleased and offered the wise man to chose his reward. The wise man asked for a grain of wheat on the first square of the chessboard, two on the second square, 4 on the third square and so on, doubling the amount of grains for each subsequent square.
Amused by such a modest request, the king ordered the wise to be paid at once, only to discover that there was not enough grain in the entire kingdom to fulfill that request.
I highly recommend you try to do the math, (spreadsheets are great for that kind of fun).
By square 24, the amount is about a metric ton. The final amount (at square 64 plus all previous 63 squares) is around 1.2 trillion metric tons. The World produced around 700 million metric tons of wheat in 2013. It would take roughly the global production of wheat since the dawn of agriculture to pay off that debt.
The opposite riddle concerns lily pads on a pond.
On day one, two lily pads are on the pond. Each day they double in number; day two, four lily pads; days three, eight lily pads, and so on. The pond is completely covered with lily pads after exactly 28 days. At what point is the pond half covered by the lily pads?
Jumping to conclusion would say that the lilies covered half the pond in the first two weeks and the other half during the last two weeks but we are dealing with imaginary geometrically growing lily pads here. If they double in number the next day, that means they were half as many the day before.
So they cover half the pond on day 27 and complete their pond-domination scheme the next day by doubling in number overnight.
Exponential growth is tricky because our brain is wired for linear consideration and is blind to other forms of progression.
Now, would you like to be paid a penny on day one, doubling every day for a month? (making 64 cents on your first week...) Or rather sign up for a solid 100K for the same month? You guessed it, the penny-a-day approach yields a cute 5 million dollars at the end of the month. (10 millions on a 31 day month)
Again as the chart shows, the Exponential Growth looks like a lot less for a long time
(64 cents at week 1, $82 at week 2, $10K at week 3...) then:
- Day 24, 84K
- Day 25, 168K
- Day 26, 336K
- Day 27, 672K
- Day 28, 1.3M
- Day 29, 2.6M
- Day 30, 5.2M
Showing the last 5 days on the chart would stretch it 10 times higher, so it is truncated to reasonable size. You got the point of this riddle.
Exponential growth in real life
Exponential growth in life is present in situations like walking with a load. The load feels light at the beginning but as time goes it feels heavier and heavier. Because the load makes you tired and being tired makes the load feel heavier, which makes you more tired, which makes the load feel heavier, which makes you more tired, etc. Everyone experience it, having to change shoulder more and more often until the need to take a break comes and then taking breaks more frequently. Usually it only becomes a funny anecdote where you eventually hailed a cab unable to carry it for the last 50 yards.