If offered, would you rather take a penny that doubles every day for the next 30 years, or a million Rupees now?
Albert Einstein famously said that Compound Interest is the most powerful force in the universe. He called it the eighth wonder of the world. Interestingly, he went on to say that one who understands it, earns it, and one who doesn't, pays it!
Imagine that you take a piece of paper, and fold it in half. Now you repeat this process about 45 odd times. How high (thick) do you think it will become? Will it be higher than your desk? Hmmm, maybe. Will it surpass your height? Tough to say.. Will it go higher than your ceiling? I seriously doubt it. Will it be higher than than a building? Of course not! Now, what if I were to tell you - the thickness will be more than the distance from here to the moon.
Forbes Magazine called it the Seduction of the Exponential Curve'. We will study in this article, the concept of compounding in its simplest terms, its profound impact over a period of time and its applicability in all walks of our life.
Impact of time: If you invest your money at 10% for five years, you will multiply your wealth by 1.6 times. Now if you invest that sum for 30 long years, your money won't multiply by 10 times. You will multiply it by over 17 times!
Impact of Rate of Return: If we change the interest rate from 10% to 15%, you will multiply your wealth by 2 times in 5 years (not too bad), but by a whopping 66 times in 50 years!
The good news is that compounding works not only for money but also for the valuable things in our life - knowledge, relationships, health, love, skills. All these aspects of life behave like compound interest, slowly in the beginning but robustly over time. The question then is, how can we apply this simple but profound concept to our daily lives?
Let's first address the applicability of the power of compounding on money and get it out of the way.
In my previous article, I had talked about developing the habit of savings and investments early on in life. And also how we can make a smart choice of suppressing our expensive desires of today. This can lead to a delayed gratification of a completely different order, a few years later.
By forming the right habits of savings and wise investments, a young person, even without doing anything extraordinary, can aim for financial independence, much before attaining the age of retirement. A simple trick but ignored by most. Look around and you will find people nearing retirement who could have earned and saved this kind of money (inflation adjusted) in their youth, finding themselves worried about their future. As mature youngsters, let's not commit the same mistake.
Similarly, investing early and re-investing often into relationships, health, abilities, etc. they will all compound and eventually begin to yield exponential returns.
Knowledge compounds like nothing else. Buffett said, "Read 500 pages a day. That's how knowledge works. It builds up, like compound interest. All of you can do it, but I can guarantee not many of you will do it." As humans, we have a tremendous potential to compound and grow by being learning machines. Charlie Munger (Warren Buffett's partner at Berkshire Hathaway), one of the wisest men alive at 96 years, says that if every day we sleep a little wiser than when we woke up, and we live decently long enough, we will typically get what we deserve.
The tricky part, however, is how do we acquire knowledge in a consistent, meaningful and effective way. Developing a deep desire and motivation to learn (irrespective of the need for immediate results) and inculcating the habit and discipline of reading and learning in our everyday life are the 'simple but not easy' ways to compound knowledge.
Health doesn't improve as we age from being young to old. However, the pace of ageing is a direct function of how we treat our body and mind over years. Mr. Warren Buffett has given an excellent analogy on this when he asked - if you one car and were told that that's the only car you will have in your entire life. How would you treat it? Wouldn't you keep it serviced, change the filter regularly, check the tyre pressure as per required frequency? Now, we have only one mind and body. So let's exercise our mind and body to keep them in good check. The compounding effect will be seen over the long term, when we need them the most.
Abilities and Skill are seldom built in a short span of time. Such is the law of nature. Sachin Tendulkar's effortless strokes, Lata Mangeshkar's melodious performances and RK Laxman's cartoonist expressions kept improving over time - much even after they already put a stamp of their skill in their respective area of talent. Whether we become a doctor or a coder, an architect or an entrepreneur, our eventual ability in our area of competence will be a function of learning/unlearning and their continuous application over long, tiring and exciting years.
Money makes money. And the money that money makes, makes more money. - Benjamin Franklin.
(Isha Kanodia is a, Corona Warrior, 16-year-old youth columnist and founder of the revolutionary website: www.staysafepowai.info, views expressed are the authors own and do not reflect the editorial policy of 'The Watchdog News.')