Albert Einstein is supposed to have said, “Compounding is the eighth wonder of the world.”
It’s easy to see why. It’s common knowledge, but it’s still powerful to see it through numbers, even to those familiar.
If you start off with Rs.1000 at age 24 and invest it at 6%, you’ll end up with Rs.16000 when you’re 72- sixteen times what you began with. Change the thousand to lakh or crore, and the impact is much more significant.
If you invested it at 9% (3 percentage points more), you’d end up with Rs.64000 at 72 – that’s sixty-four times what you began with and four times more than what you got at 6%, although the change was just 3 percentage points.
If you began earlier – if someone invested the money for you when you were born 24 years earlier – you’d end up with Rs.64000 in the first case and Rs.512,000 in the second. That’s 4x the first case and 8x the second one.
This tells us a few things –
- What return (rate of interest) you get matters a lot. A small percentage change can multiply your earnings.
- How long you invest matters. The sooner the better. The best time is now.
- How much you start with matters but it’s often not in your hands- start now with what you have rather than waiting.
More than Money
Most people know how compounding can multiply their money, but they don’t realize its significance in other domains.
This picture is probably familiar.
It basically reinforces the idea that if you keep trying a tiny bit harder and improving every day, after a year the difference will be tremendous. A 1% improvement a day means a 38x improvement after a year.
And a 1% deterioration a day means you’ll end up at barely 3% of what you were.
This is true, and it’s great to keep in mind, which is why it’s often used as a “motivator”, but that’s not what this post is about.
This picture simply applies a mathematical formula (1.01^365) to a variable – the variable could be money or “self-improvement” or anything.
The point is that compounding applies to nearly anything.
Compounding Skills
The basic idea is that time is a valuable asset.
Doing something sincerely for a period of time means “investing” time in it.
And time multiplies whatever you invest.
Though dedication, sincerity (in your hands) and of course natural aptitude (not in your hands) all affect the return on your investment, time is what makes it grow. Even someone without natural ability can improve with time.
Again – this isn’t anything new.
It’s basically saying “You’ll get better at things with time.”
Slightly less cliched is the idea that knowledge and productivity compound.
The more you know, the more you learn.
The more you learn, the more you can do.
The more you can do, the more the opportunity.
It’s far easier for a person with money to make more money, because of the opportunity open to those with money. Going from the first billion to the second would probably be much simpler than getting to the first billion.
And to those with experience in their field, far more opportunities and roles are open, and much more freedom in choice of work.
In essence:
Being at level X in something and being at level 5X are completely different.
Level 5X is not “five” times better than level X – it’s probably closer to 50 times.
Because knowledge, productivity and opportunity also compound with each level. And the differences add every year.
Which is why a great singer or programmer or entrepreneur or actor would probably make hundreds of times the money as an average one – even if his skill is 5x or 10x times that of the average one.
The Power of Small Things
Compounding is what makes small habits powerful.
The difference between eating out and having homemade lunch might be Rs.1000 a month.
Going back to the first example – saving a thousand bucks a month for 48 years could bring you between 33 lakhs to 1 crore depending on how you invested it.
It doesn’t mean becoming a Scrooge and never eating out – it’s just worth keeping in mind because a lot of these decisions are dismissed as trivial or not really thought through.
Small actions repeated over and over again aren’t really small. They only appear that way because they’re seen through the wrong prism as isolated actions.
So someone might think that the difference between eating out and having home-made lunch is only Rs 30/day, which might look insignificant. But that 30/day compounded for years isn’t likely to be insignificant.
Of course, there’s a time factor too – making your own meals has an opportunity cost in terms of time and effort. Which is why you’d rarely see rich people cooking – because they can afford to spend the money, but not the time. You can’t get away from cost-benefit analysis.
And it applies just the same to things other than money.
Given two people with exactly the same ability, the one person who manages day in and day out to get in one more hour of thinking will be tremendously more productive over a lifetime.
Richard Hamming
Knowledge and productivity compound as well, so small differences add up over time and become significant.
That extra one hour a day compounds – it’s like the difference between earning 8% or 9% interest on your money. After some years, the difference is in multiples – one is double the other.
That’s why tiny habits – reading a few pages a day or spending some minutes practicing a skill – matter.
Reading 2 pages a day means reading roughly 2 books a year. Anything you get from those books will stick with you and compound – it’ll add some value to every remaining year of your life.
So a good book can potentially improve 40 years by perhaps 0.1% each (a very tiny change) which is 1.001^40 or a 4% increase.
And every good book adds on to this, so 10 good books could bring you a 49% increase.
Compounding as Motivation
Compounding is also one of the most powerful motivating forces I know of, better by far than any inspirational talker or success story.
When you’re learning something new, and you’re doing it for the long haul, you often struggle, sometimes thinking of giving up. Usually it’s because it’s hard and you’re not good at it.
Just think of the future, when your effort has compounded.
Today I’m terrible, but if I keep making time for this every week, in 5 years I probably won’t be that terrible. I just have to persist. Being a noob is temporary – there might be other reasons to give up, but that isn’t one.
Or struggling to find one’s feet in a new role – the initial awkwardness and pain is temporary. Thinking a few weeks ahead often helps.
Zoning out and understanding that skill comes with compounding helps to get over present lows.