When you study people who have found success in any area of life, whether it be relationships, finances, career, fitness, or creative outlets, a common element of their narrative is that they used the incredible power of compounding growth to their advantage.
Compounding growth is one of the most powerful forces we can use to our advantage, and for this reason I believe that one of the best heuristics for living is to do things that positively compound. In this post I'm going to give some background on the concept of compounding growth and then explain how you can apply compounding growth to improve your life.
Albert Einstein famously claimed that compound interest is the most powerful force in the universe. He said:
"Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it."
Einstein understood how compound interest uses the incredible power of exponential growth, and that it can either help you or hurt you.
Similarly, Benjamin Franklin used compound interest to benefit his community for generations through a gift upon his death. This little known fact about the polymath and Founding Father is that Franklin created a philanthropic trust that gifted 1,000 pounds (about 4,400 dollars) each to both Boston and Philadelphia in 1790. The funds were to be used to provide small loans to married men under 26 years old who had completed an apprenticeship and wanted to start a business. The loans were to be paid back at 5% interest, and after the first 100 years, the cities could use 75% of the accounts to fund public works projects while reinvesting the remaining money. At the 200th anniversary of Franklin's experiment in 1990, his trust had grown to over $6.5 million. Had the cities not spent part of the accounts in 1890, this number would have been even higher!
Franklin was no stranger to the power of compound interest, and his used this multi-century financial demonstration to show how a very small amount, when allowed to compound modestly over a long period of time, could be enough to impact whole cities.
The effect of compounding relies on the concept of exponential growth, which is a fundamentally unnatural concept for humans to grasp. As humans, our minds are conditioned from birth to think of growth and change in linear terms because that is how we experience the world around us. Linear growth is when the slope of the graph or the change of something over time is constant. We age one year at a time, walk one step at a time, and the sun slowly and steadily moves across the sky from dawn to dusk each day.
Unlike linear growth, with exponential growth the rate-of-change increases over time because of a snowballing effect that is applied to the initial amount. As the amount gets larger, the rate-of-change (the slope of the graph) increases or gets steeper.
To illustrate compounding interest, let's use an example of an initial investment of $1,000 growing at 5% compounded annually for 10 years.
If you look at the change column, you can see that the total account increases by a greater amount each year. This is the nonlinear part of exponential growth, where the rate-of-change is increasing. This becomes especially powerful over longer periods of time. The element of time is crucially important to wielding the power of compounding growth.
While the savings account only grew about $78 year-over-year after the 10th year, or 8% of the initial amount, by the 40th year, the savings account will grow $388 year-over-year or about 39% of the initial amount. By year 64, the account will grow by $1,030 year-over-year, more than the initial $1000 that was put in to start the account! In the first few years, the compounding starts slowly and is hard to notice, but over time it becomes immensely powerful.
I believe that one of the best heuristics for how to focus your time and energy in life is doing things that compound.
With every decision you make in your daily life, you can choose to do things that positively compound, negatively compound, or don't really compound at all. Doing things that positively compound will slowly and incrementally make your life easier, however they will feel hard at the beginning. Conversely, things that negatively compound often feel easy in the moment but have negative effects long term.
Some things that don't appear to compound can indirectly enable compounding in another area. For example, you shouldn't immediately go and quit a boring but well-paying job that is enabling you to invest your savings in assets that do compound. However you should consider how you can steer your career over time towards doing work that energizes you and builds skills that you value for the long term.
Nat Eliason frames this heuristic really well in his article titled 30 Year Thinking with a simple question: What do you want to be doing in 30 years? By asking yourself this question, you are effectively reverse-engineering compounding growth by asking yourself what things can I do now that will compound over the next 30 years to get me to my desired outcome?
Doing things that positively compound will usually start out difficult with small returns, but you experience a flywheel effect where the longer you practice something, the easier it gets and the bigger the benefit to you. Starting an exercise regimen is difficult at first, but over time as you become faster and stronger, you build a foundation which makes exercising a fun and integral part of your life. Similarly, cutting your expenses to live below your means is painful at the start, but once you readjust your lifestyle to find joy in the simple things in life, living below your means becomes a habit. You gain the freedom of needing less income and the ability to save and invest your surplus in assets that compound themselves, like stocks and real estate.
As you go through life, reflect on your decisions and ask yourself: Am I doing things that will positively compound over the next few decades? If the answer is no, then dig deeper and ask yourself, How can I steer my path, each day, so that my actions enable me to begin experiencing the effects of positive compounding? Whether it be in your relationships, your finances, or your craft, doing things that positively compound is key to long term success and satisfaction.
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