Dateline: Kuala Lumpur, Malaysia
At Nomad Capitalist, we tend to speak primarily to six- and seven-figure entrepreneurs.
As such, many of my articles on finance are meant for people who already know what they’re doing with money. If you have a boatload of debt or your savings account is hanging on by a thread, then investing in foreign real estate or creating an international CD ladder should be the least of your concerns.
But even if your business is making a million dollars and your investments are extensive and diverse, whether having real estate investments, mutual funds, ETFs, or other investments, it’s still good to get back to the basics every now and then.
Today, then, I want to share with you a classic story that you’ve likely heard before: what happens when you double a penny every day for thirty days.
As always, however, I’ve put my own Nomad Capitalist spin on this classic bit of financial wisdom.
In this version, we’ll also talk about how much you’re losing if you’re penny doubling that in a high-tax country. The fact is that even if you’re as financially savvy as they come, none of it matters if you’re losing a sizable chunk of your income to the tax collector.
This article will recount this classic bit of financial wisdom and then tell you how you can take this simple knowledge to the next level by applying our Nomad Capitalist principles to it.
Double a Penny: the Basics of Compound Interest
A while ago, I was speaking to a friend of mine who has an extensive background in mathematics.
As we were talking and catching up, we got onto the subject of compound interest. We discussed how he’s growing his business and how quickly he was turning his capital over and putting it back into the company.
You see, compound interest, or compound growth – which can be roughly defined as “interest on interest” – is one of those financial concepts that seem difficult to grasp until you see it in action, which is where the penny that doubles example comes into play.
When I was a kid, someone once asked me whether I would rather have $1,000 upfront or if I would want to double a penny every day for a month.
Being young and unaware of the power of compounding interest, I said I’d take the $1,000. That’s far more than a penny, isn’t it?
Naturally, I was wrong.
After getting a penny doubled everyday for thirty days, you’ll have $0.01 on day one, $0.02 on day two, $0.04 on day four, and so on.
While those numbers might seem like chump changes at first, take a look further down the line if you keep accruing 50% interest on your whole investment each day.
On day 15, you’ll have $163.84, and on day 20, you’ll have $5,242.88. As you keep doubling that number, you’ll end up with $5,368,709.12 at the end of thirty days.
That’s not half bad, is it?
You see, that’s not a magic penny. That’s the beauty of compound interest.
Even Albert Einstein said, “compound interest is the eighth wonder of the world.”
As you continue to earn interest on your initial investment as well as the interest that it accrues, you’ll grow your wealth more and more quickly.
While there are different versions of the story, the principle is the same: if you allow even a small amount of money to accrue interest (and you save that money, of course), you can end up with far more than if you had just accepted a seemingly large amount and stuck with it.
Double a Penny in The Real World
Although the double a penny concept is a fun mental exercise, it doesn’t reflect how things work in the real world.
Not only will you be hard-pressed to find something that gives you a 50% daily interest rate, but you also will need to contend with plenty of real-life obstacles.
In my line of work, I speak to many people who are gaining momentum in their business or investments, and they want to put as much money as possible into their Amazon inventory or their cryptocurrency investments.
These people are running the same kind of double-a-penny simulation in their own lives as they try to make as much money as they can by taking advantage of compounding interest.
And many of them are starting to make good money, and they want to invest back into the business – but they can’t do it fast enough.
One of the largest speed bumps that they hit is taxes.
You see, when we talk about financial concepts in school, we don’t talk much about taxes, but most business owners and investors have a palpable, real-life impact on their earnings.
Think about it – if you take a standard 35% tax rate out of the penny that you double every day, then you come out with a lot less money than you would if you didn’t pay any taxes.
So, if one penny doubles to two pennies, then you lose one-third of a cent on that day’s gains, which means that you have less money to double the next day. As that trend continues for thirty days, you’ll end up with just $20,000 at the end of the month.
That’s a far cry from the $5.3 million that you’d have without taxes.
Obviously, in the real world, things don’t work so cleanly. You likely won’t be able to double your money every day, and other business factors, such as inventory or employee turnover, can also hurt your bottom line. However, as a business owner or an investor, you pay more attention to those larger expenses than gradual ones like taxes.
However, just like interest, taxes also add up over time, but since it’s so gradual, you might not be able to see just how much you’re actually losing out to them.
When you’re paying more in tax, you have less money to reinvest in your business, which lessens its potential for growth and the amount that you can sell it for in the future.
The difference between what you can earn with taxes and without taxes is stunning.
Say you own an Amazon business, and you realize that you can double your money every year by turning it over into stock in the stock market. After thirty years of doing business and investing in that way, you’ll end up with a pretty substantial profit. However, if you’re staying in the US, Australia, or another high-tax country, you’ll be losing a large chunk of your money to taxes every year, and that’s money that you can’t get back and reinvest.
The bottom line here is that in the real world, you become less able to grow your wealth when you’re paying a lot in taxes.
Additionally, in many of these high-tax countries, you also have social pressures that push you to spend more money, which you need to account for in your double a penny scenario. No matter where I go in the world, people tend to spend what they earn – even if they’re doing pretty well for themselves.
I once knew a guy in Denmark who was making around €350,000 per year. That’s not a huge amount of money, but it’s still pretty substantial – and certainly enough to start investing early and seriously expanding your wealth.
However, at the end of the year, he had nothing left because he had to pay Denmark’s high taxes, and on top of that, he tried to keep up with the Joneses and buy the nice Audi and the house in a nice neighborhood.
To many people, this seems a bit preposterous. How does someone make such a comfortable salary yet still end up with nothing at the end of the year?
See, when you live in an environment that holds you to certain social standards like having a nice car or buying certain clothing brands, you also detract from your overall financial markets gains by taking away money that you could be reinvesting in your business.
Therefore, in the real-world version of this double-a-penny scenario, you end up with a lot less at the end of the game when you account for taxes and spending on status symbols.
How to Change The Game and Earn More Money
After thinking about how much you’re spending in taxes or on status symbols, you might be wondering how you get out of that trap to earn more money and grow your wealth even further.
The answer is simple but not easy: you remove yourself from your current situation.
You need to get out of that rat race where you have those social constructs as well as that high tax burden in order to overcome those problems and increase your overall earnings.
In fact, by saving or investing that kind of money, you can earn billions more over the course of your lifetime.
However, to do just that, you’ll need to make some major life changes.
The first thing that you’ll need to do is change your mindset. You’ll need to be open to making major lifestyle changes like living abroad, and you’ll need to begin to remove yourself from those social constructs that push you to buy things that you don’t want or need.
From there, you’ll need to take action. For some, this might mean working toward renouncing US citizenship by building a passport portfolio, and for others, this might mean becoming a tax non-resident at home and moving somewhere where you can pay low or no taxes.
Your strategy will differ depending on your individual needs and circumstances, but at the end of the day, it’s all about lowering your taxes and enhancing your personal wealth.
While this might seem difficult, it’s necessary to get the most out of your money.
It’s Time to Take Action
As you can see, compound interest works both ways. While it can be a vehicle to grow your wealth, it can also refer to the subtle way in which things like taxes or buying status symbols can slowly chip away at your wealth and ultimately decrease your overall earning ability.
The fact is that these things cost you not only in the near future, but they’ll also lessen the opportunities and wealth that you’ll have later on down the road.
You might have to sell your business for less since you couldn’t invest as much in it, or you may not even have as much money to pass down to your kids.
So, how do you make sure that doesn’t happen?
You can take action today and begin to build your Nomad Capitalist lifestyle.