The Rice Parable: A Simple Way to Understand Compound Interest

Today let’s talk about compound interest.

The eighth wonder of the world, according to Warren Buffett.

If you allow me, I want to give you a simplified overview of it.

You know, the type that even an 11-year-old kid can understand.

Because after all, complicating things doesn’t add any more value to our lives.

So, what is compound interest? 

That question can be easily answered with a parable. 

Actually, the parable I‘m about to tell you is the parable Mike shared in our podcast conversation.

And I want to share it with you because it perfectly explains the magic of compound interest.

If you’re not the reading type, I have prepared for you a 1-minute short clip from the episode.

You can watch it here:  https://www.youtube.com/shorts/ZRRl52L014E

But if your brain prefers reading, let’s begin.

The story is called The Rice Parable.

And it goes like this:

Back in ancient times, a wise man invented the game of chess. 

The king of the kingdom loved the new game so much that he wanted to reward the man.

So, he asked the man to name his reward.

The wise man thought for a moment.

And finally asked for something simple.

Or so it seemed.

He requested one grain of rice to be placed on the first square of the chessboard.

Then, to double the amount for each following square.

So, 1 grain of rice on the first square.
2 grains on the second.
4 on the third.
8 on the fourth…

And so on, doubling with each square until the board was full.

The king, unaware of how compounding works, thought it was a humble request. 

But as his servants began placing the rice, the numbers exponentially grew.

By the time they reached the 20th square, the king owed more than a million grains of rice.
By the 40th square, it was over a trillion grains.
And by the 64th square, the amount of rice was so enormous that it surpassed all the rice in the kingdom, and even the world.

And although that parable is fictitious, it clearly explains the power of compounding. 

How Compound Interest Works When It Comes to Money?

Now, let’s connect this to money and investing.

And here, there is one important thing I want you to remember.

When it comes to compound interest, time is the most important factor.

It’s not the initial amount that matters most, but time.

So, that means when you hear money, investing, and compounding in one sentence, you should immediately think of long periods of time. 

Because the longer the time, the greater the growth on top of the growth.

Let’s see an example. 

If you are visual, this video is for you: https://www.youtube.com/shorts/2Uw71i7r1LU

If you invest $100 at 10% interest. After the first year, you have $110.

In year two, you don’t just earn 10% on the original $100.

You earn 10% on $110, ending with $121.

That means, instead of earning $10 on interest, you now earn $11.

In year three, you earn interest on $121, bringing you to $133, with the interest being $12.

As you can see, each year the interest you would earn keeps on growing. 

In the first few years, this may not seem much.

But if you are patient and allow compounding to work for a long period of time, the interest will start growing at a greater rate every year. 

So, by year five, your original $100 would have become $14, with $15 in yearly interest

By year ten, you would have $236, with $24 yearly interest.

By year twenty, you would have $61,2 with $61 yearly interest.

By year thirty, you would have $1586, with $159 yearly interest.

And by year forty, you would have $4,11,4 with $411 yearly interest.

Can you see how something small can grow into something much bigger over time? 

It looks slow at first, almost insignificant.

But give it time, and the numbers start to look like the rice on the chessboard.

Multiplying at an exponential rate.

The Key to Compound Interest is Time

Here is what you need to remember.

Compounding needs time to do its magic.

It’s not the same to start investing at 20 than to start investing at 40.

As with one you would have four decades of compounding, while with the other only two.

Those two decades matter.

And quite a lot.

Because as you saw in the example above, the later decades grow much faster than the early ones.

Missing out on them is not a small detail.

That’s why when it comes to compounding, the most important investment decision you can make isn’t which stock to pick.

But it’s to start early.

Compound Interest in Real Life

The Rice Parable sounds great, but where do we actually see compounding in real life?

Let me give you two cases.

One positive and one negative.

Let’s start with the positive case:

Retirement.

Perhaps you knew this or not but retirement accounts use the magic of compound interest.

You start investing early in your career, usually in your 20s, and let it grow until you reach the standard retirement age at 65. 

That means, 30-35 years of compounding.

Partially, that’s why you’re encouraged not to touch those accounts early.

Although on the other hand, investment institutions benefit from holding your money for decades.

But let’s leave that conversation for another day.

Today the bigger picture is: time works in your favor.

Now, the negative case.

Debt. 

Debt also compounds but against you.

The longer you make the minimum payment, the more interest compound on your debt.

Meaning, the slower you are to repay your debt, the more you end up paying overall.

This applies to credit cards, mortgages, car loans, student loans, etc. 

That’s why the sooner you pay down debt, the better off you are.

Perhaps now you also understand why they promote more minimum payments rather than bigger payments.

Anyways.

Final Thought

The Rice Parable shows us a truth that feels almost counterintuitive.

Small, steady growth may not look impressive in the beginning.

But with time, compounding makes things grow exponentially.

This is why compound interest has been called the eighth wonder of the world.

Remember.

It can work against you if you’re carrying high-interest debt.

Or.

It can work for you if you start saving and investing early.

https://www.youtube.com/shorts/elVUDALoVq0