If you really want to thrive in life, gaining a thorough understanding of compound interest is essential. Not understanding compound interest is one of the main reasons many people fail their New Year’s resolutions, spend middle and older years in poor health, and end up on Social Security.
Yet the most dangerous thing about compound interest is that it doesn’t require your understanding or attention to affect you. Compound interest is shaping your life across multiple dimensions right now, whether you recognize it or not. And unless you become aware of the profound effects of compound interest and begin to use them to your advantage, you will be the unwitting victim of these forces.
How powerful are the forces of compound interest? In the words of Albert Einstein, a scientist not known for his exaggerations, “Compound interest is the eighth wonder of the world. Whoever understands it, earns it… whoever doesn’t understand it…pays it.
A story from Indian mythology illustrates the power of compound interest. This story describes a game of chess played between a wealthy king and a deity disguised as a traveling sage. If he was victorious, the sage asked the king to pay him in a grain of rice for each square on the chessboard, starting with a single grain and doubling with each of the next 63 squares. The king didn’t think to calculate what seemed like a modest prize until he lost. He realized that the total amounted to more than 500 billion tons of rice! Here is a video of the story.
Another demonstration of the effects of compound interest is the wealth accumulated by Warren Buffet. Buffett started investing when he was 12 years old, investing “self-funded” by the money he earned by delivering newspapers. As he invested and increased his investment knowledge over time, his wealth grew in accordance with the principles of compound interest.
At 30, Buffett has gone from a few dollars to a million dollars in his wallet. That was a lot for a 30-year-old, but not something that would make him a household name. It was only with additional years (think money and years like grains of rice and squares on a chessboard) of persistent investments that he reached his first billion in his fifties.
With additional funding, it was worth >15 billion at age 65 and >85 billion at age 88. Note that Buffett started investing so early. He has been investing and compounding his interests for over 75 years.
The effects of compound interest over time are why it’s so important to start your investing habits, your exercise habits, your nutrition and sleep habits, your reading and learning habits. , etc., as soon as possible – or at least as soon as possible – to give your future self the gift of compounding. See more of Warren Buffett’s story.
Source: Image by OpenClipart-Vectors from Pixabay
As dramatic as these examples are, make no mistake: the cumulative effects are not limited to grains of rice or money. And they can either help or harm (eg, worsen the harms of smoking and alcohol abuse, poor diet, exercise, and drinking habits over time) depending on the application. They apply to your career, your parental and romantic relationships, your health and your quality of life. Whatever area of life you consider important, whatever your definition of personal success, the effects of compound interest shape your bottom line.
The effects of compound interest are not intuitive for us because they are not linear. The human brain, by default, thinks linearly. We expect, for example, that our time, money and effort will be rewarded in proportion to the amount we invest in it. But that’s not how it works at all. Instead, assets such as time, money, and effort often yield minimal rewards at first. Faced with disappointing first results, we often give up, but not only because of this short-term result.
Instead, we believe the relationship between effort and result should be linear. We also believe that the low return we got from our initial effort means that the same result will continue. So we are not continuing. In reality, the small initial gains we experience often operate under our consciousness, like those meager initial doublings of grains of rice on the chessboard or the modest first investment dollars in Buffett’s portfolio.
Despite the modest beginnings of our exercise, nutrition, weight loss, or learning efforts, the effects of compound interest will reach a point where the payoff will become enormous. We just have to be patient and persistent long enough to make it happen.
Experts like James Clear, author of Atomic Habitswrite extensively about using the principle of compound interest for habits, whether they apply to health, wealth, or happiness.
Whatever your goals, the potential that results from compound interest requires three critical behaviors from you and me:
- Departure – not how much you start or how fast you start, but just starting.
- Consistency – avoid failures, do at least a little even if you don’t know how to do much, bounce back quickly after bad days.
- Take the time, your friend – patience and perseverance; think long term; resist impulses and short-term distractions.
Whether you want six-pack abs, a million-dollar wallet, or an amazing wedding, the choice is clear: either make compound interest your best ally, or it will become your fiercest adversary.