Compound Interest 1.0

Before kicking off, I’d like to pose a question. Let’s say your friend comes to you and asks you to invest in his business, promising you that he’ll return your money with a yearly interest of 11%. That’s not a random number, the US stock market has been growing 11 percent annually over the past 33 years. But you don’t really trust your friend, so you say “sure, I’ll give you one dollar to start your business.” For some reason, your friend agrees to take this one dollar, instead of leaving in a huff over this insulting offer. How much would you expect him to return to you after one year, not including your original money?

Well, 11 cents of course because the interest rate is 11 percent. If you take this interest money from him at the end of each year, you’ll end up with a total of $4.30 after 30 years, including your original $1.

Now, let’s consider another scenario. You tell your friend, “It seems your business is growing, why don’t you just reinvest that 11 cents?” He agrees to the terms and both of you are happy. After 30 years, you’ll end up with $22.89. BUT, we’re not done yet, you really want to be generous to your friend, so you offer him a deal that he can’t turn down, you say, “Hey man, I really trust you NOW, and I know you’re a very good entrepreneur, so not only can you reinvest the yearly interest, I’m going to invest an additional dollar in your business every year.” Now you’re becoming extremely generous to your friend. Your generosity actually works out and at the end of 30 years you end up with…? Any guess?

$221.91.

I’m telling you all these numbers because numbers are more tangible for us to understand the concept of this post, compound interest.

A few years ago, I was having a conversation with a friend of mine who was spending around $10 a day for his breakfast at Starbucks. He was complaining that he should be making more money, so that he could afford to travel abroad. I told him “Why don’t you save some money by cutting $5 from your daily Starbucks(or similar) expenses and do micro-investments with that?” We did some simple math and it became obvious that if he just puts that $5 in an investment index fund, he would have more than $6,000 after 3 years. This amount of money is enough for three people to have a pretty good trip to Europe for two weeks. Remember, here time is your friend. As the time passes, children of your money make children. The same way cockroaches in your kitchen reproduce.

Compound interest isn’t a distant concept to us, it’s not just limited to the business world. In fact, I believe most things that work well or terribly in real life benefit or hurt from compound interest. Here are some examples of those:

• The British Empire didn’t shrink overnight. It happened territory by territory.
• U.S. didn’t become an economic and political power overnight. I mean, of course, Benjamin Franklin had to spend a lot of nights with women in London and Paris for it to happen.
• Michael Phelps didn’t win the record for the most Olympic gold medals overnight. He came back home from the 2000 Sydney Olympics without even a single medal.
• Nelson Mandela didn’t become a symbol of fight for freedom overnight. He did that while he was in prison for almost 30 years.
• You won’t get sick if you smoke just once, but constant smoking degrades your health. It’s a killer that seeks help from compound interest.
• Trust between people and long-lasting relationships are based on compound interest. You first trust them when you give them your phone number. You trust them when you go out with them for dinner. You trust them when you invite them to your house. You trust them when you tell them your secrets. Here is compound interest at work, working it’s magic.
• Look at your good habits that you’re proud of. They did not happen overnight. They compounded consciously or unconsciously.
• You heard that people usually say wealthy people are frugal or stingy. I disagree with that. They are not frugal, they know what compound interest is.

You don’t have to be religious, atheist, or agnostic to appreciate the effectiveness of religious rituals. Let me give you an example… in every major religion, they repeat the same verses every day or week. Why? Because our brain evaporates information so fast. Aristotle says “You are what you do repeatedly”. Directed and planned repetition is the driving force behind compound interest.

In fact, for most of what human beings want to achieve, it’s better to hand it to compound interest, it will work its magic throughout. You have to work hard, but more importantly you have to work smartly and consistently. Which will lead into the Matthew effect “Unto those who have shall be given, unto those who have not should it be taken away” or “Those who have much will receive more, and they will have more than they need. But as for those who don’t have much, even the little bit they have will be taken away from them.”

Now, I would like to talk about a cousin of mine who is the symbol of compound interest for me. Her name is Homa. On a humid day in June 2005 the phone in our house started to ring. It was my uncle, calling my mom to join the family at the hospital immediately. Homa’s husband had just gone into coma. He was a metal-smith and was doing some community service on a weekend at an elementary school near their house. He was trying to fix an unstable wall, suddenly, the whole wall collapsed on him and he went into a coma. Unfortunately, he did not recover from the coma. After one week, he left Homa, forever. At the time, my cousin was around 30 years old with two kids. I remember visiting Homa to console her at this great loss. But she said something to me that stuck with me even to this day. She said, “I wish he were just alive. I would accept him even if he were just like a mute statue sitting next to me.” Her husband left her with a large amount of debt, a really large amount for someone who had never earned money in her life, YET. To give you an idea of the size of debt, it was equivalent to the annual salary of a school teacher at the time. Yet today, Homa is living a pretty decent life and running three businesses simultaneously. If you were to go back in time to 2005 and tell her that in 2019 she would be at where she is now, she would think you were insane. How did she manage to clear the debt, start multiple businesses, buy multiple properties, AND raise her two kids? Well, compound interest was doing its job behind the scene. Did she start all of those businesses overnight? No, not at all. In all these years she worked tirelessly in rice fields as well as running businesses in order to clear her husband’s debt that she had inherited. She gained strength from the love of her kids and pushed herself to excellence despite being a simple housewife at the age of 30 without a proper education. She’s been implementing it consistently over the past 14 years. Slowly but consistently.

Finally, while I was preparing this writing I was thinking of some other examples of compound interest that I grew up with. Rice Fields: Before planting the rice seedlings, you have a tiny bed where you plant the rice seeds, and later you transplant those seedlings into larger fields. A rice bed double the size of your bedroom is sufficient for a one acre field. In other words, farmers are hoping to get 50 to 100 times the amount of seeds that they plant depending on the type of seed. What kind of seeds are we putting into our rice bed? What percentage of our daily time is spent on things that can gain from compound interest? Slowly … but Consistently.