#SoG38 — What is the 8th wonder of the world?
Guess what is the 8th wonder of the world?
Take a guess.
Please.
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Compounding!
Einstein apparently said that compound interest is “the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”
Snopes may not agree. And if we agree with Snopes and look at other giants, compounding has indeed played a large role in the lives of legends like Munger and Buffett. People have called it the greatest invention of mankind, the “real” magic and what not.
I’d say compounding is probably the most potent force hidden in plain-sight.
Lemme explain.
Wait. Before that, what is compounding?
Compounding is the process in which an asset’s earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. This growth occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods. Compounding, therefore, differs from linear growth, where only the principal earns interest each period.
This is a slightly edited definition that I found here. A longer note on compounding is on this link.
Here’s a chart to explain things. A USD 1000 invested over 20ish years, at a 10% ROI.
You see how that 1000 bucks could become 7000+ (instead of 3000 if it dint compound)?
And you dint have to move a finger or do an iota of work!
Do you see the power of compounding?
Want a more vivid, visual method?
Lets play a game.
Of chess.
If I asked you to place one grain of rice on the first square, two on the second, four on the third, eight on the fourth and so on, how many grains would you need to cover the entire board?
Guess?
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I wont dazzle you with a number but it would be enough to… cover the surface area of whole of India, 50 times over!
See this video — https://www.youtube.com/watch?v=t3d0Y-JpRRg.
You may want to read more about the Wheat and Chessboard Problem.
So, what all compounds? How to use it to advantage?
We know money does.
The easy lesson is that you ought to invest early and let it compound.
Thing with compounding is that more time you give it, more returns you get.
And time is a thing that does not come back. Its irreversible. Thus, the best time to start is today.
Go invest whatever you can and let it compound.
Is there more?
So, if we go a tad deeper and try to think, what else compounds, what would be a few things?
Here’s a list.
- Mango Trees compound. Maybe. I was trying to be funny.
- Relationships do.
- Network does.
- Knowledge does.
- Wisdom does.
- Exercising does. No wonder its often called practise.
- Your body of work (aka portfolio) compounds as well.
The central idea is whatever by repetition allows you to accrue larger results with time is where you ought to put in regular, ongoing effort. If I told you to run a Marathon right now, you probably wont be able to. But if you “practised” for it, in a few months you could. Not that you suddenly get the stamina required for a marathon. But over time you have compounded your stamina! Side note. If you can finish this book, you can run a Marathon.
And of all the things that I could imagine compounds with time (see list above), I think the network is the MOST important of them. You ought to build it one person at a time. And it requires more effort than anything else — us humans are not formulae. And no person could ever get successful without a network! Well, except one or two.
Here’s a question for you.
What can you do to start compounding your network?
Are these letters an investment that I am making to compound my network?
1000 words a day that I talked about in #SoG36? That compounds!
And if network is not your thing, I understand.
But there must be something that you care for?
How about you ensure that you make regular investments and ensure you get returns on the principal and the interest!
See BJ Fogg talk about tiny habits and the colossal impact and permanent change that compounding of these tiny habits can bring about!
Thats it. Remember. Invest regularly, and ensure that what you earn on the investment also earns for you!
Over and out!
Oh, before I end this, I have to say that PLEASE DO NOTE THAT I AM NOT GREAT WITH PERSONAL FINANCE. The letter is written with the intent of making you aware of the concept of compounding. Most of us miss it. That’s it. Nothing more. Nothing less.
PS.: Thanks Krishna for the cue.
PPS: I dont know if this is relevant but my grandma used to tell my sis and I that interest is dearer than the capital invested. And she would then say that she loved us more than she loved my father!
PPPS: Random quote that I think can find home on this piece
The palest ink is better than the best memory.
PPPPS: Issues with this idea of compounding?
In investment,
- If you are young (less than 25), for the first few years, you may not have enough to save. Thats ok. The idea is to start as soon and let the things compound.
- If you are older (more than 35), you may not have enough time left for compounding to start giving you the magical returns. I am not wise enough to recommend a course of action :(
In both these examples, replace money with that thing that you wish to grow and you would get the exact same problem. There must be a way out. Maybe different discussion, different day?
Tags: Delayed gratification, Personal Finance, Long Term Thinking, Compounding, 20s.
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