Albert Einstein called the power of compounding a miracle.
To be more exact, he said:
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”
The power of compounding is an expression for the effect when the money that you have already earned using your money, also starts making money.
What is compound interest and how can you achieve it?
In this blog post, I’ll give you five examples of it. The first is the most obvious one: your savings account.
1. Compounding With Interest
Let’s imagine you have a savings account with interest on it (as in the old days). Let’s say that the interest rate is 10% (this was actually possible when I was a child).
You deposit 1,000 USD… and then you do nothing more.
Next year you have 1,000 USD plus 10%, and that will amount to 1100 USD.
The year after that you’ll receive more than 100 USD, because the first 100 USD you earned on interest will also earn you money. Now you get 10 % of 1,100 USD.
So the interest earned on year two is 110 USD.
The extra 10 USD came from the power of compounding.
2. Compounding on Stocks
Of course, the same thing happens with your stocks.
But when it comes to shares, you may need to do something active to take advantage of it.
The money you have already earned must be reinvested in order for you to take advantage of the compounding effect.
For example, if you get paid dividends or have sold shares with a gain, you have to reinvest the return so that it’ll still make money for you. If you buy shoes with the money, you’re ruining the power of compounding.
3. Knowledge and Experience
Warren Buffett says there is power of compounding when you gain knowledge. It’s important to keep learning and reading about companies you want to invest in.
The knowledge you build makes it easier to absorb additional knowledge.
We continue building on what we have already invested in our brain.
This obviously is true for all kinds of experience and knowledge – not just investing.
4. Friendship and Goodwill
Whatever you send out, you get back manifold.
The famous value investor Guy Spier believes that one of the things contributing to his success is a habit of sending three physical thank-you letters by mail every day.
He says the little things in life can have a big effect over time. However, it can take up to five years before the effect shows up – and most people have already given up long before that.
“I now understand, this habit of writing letters is an incredibly effective way of compounding goodwill and relationships instead of merely compounding money,” he wrote in chapter five of his book The Education of a Value Investor.
“The narrowly financial application of compounding may be the least valuable and least interesting aspect of this phenomenon.”
This way of thinking is very inspiring and can really make you aware of what you are setting in motion.
One unkind word can turn into a crisis. A little well-meaning praise can be the beginning of a budding new friendship.
But it’s important not to expect an immediate and quick return on your effort.
Just give and let go. Everything comes back to you amplified – but from unexpected sources.
5. Health and Strength
The power of compounding is inherent in everything.
Of course, it also applies to your health.
If you aim to become a little healthier every day, exercise a little more every day, you can get in very good shape in a very short time.
Think about it.
If you just get one percent stronger every day, you’ll be a lot stronger after a year.
Or let’s take running as an example.
According to a very common rule of thumb, you can only add 10% to your weekly mileage (in order to avoid running injuries).
Let’s say you’re beginning a new running practice, and you’re not supposed to run more than 10 miles (accumulated).
In week two you can run 11 miles – which is really NO difference in your daily running schedule. This stuff can drive you nuts with impatience if you want to train for a marathon.
But wait, it gets so much better as the power of compounding sets in.
10 weeks later you’ll already be able to run 26 miles, and after 15 weeks you can run 42 miles. After a while, you can add 15 miles a week to your weekly total.
Obviously, there is a natural limit – you can’t become infinitely strong or run infinitely – but for a long time, you can reap the benefits of the power of compounding.
Also, there is a kind of mental compounding. When the ball gets rolling and you can feel how you’re getting healthier and stronger, you’ll feel like doing even more.
It is very motivating.
Where Do You Want to Apply this Power Today?
I could give you many more examples of the power of compounding.
In fact, it’s in everything.
Even in this blog.
Let’s say you launch a blog, and in the first year, you have around 500 readers who are mainly your polite friends and family.
But if just 8 out of 100 recommend it to a new reader every month, the blog will grow organically to 1,200 in a year and to 46,000 readers in five years (oh, please take this as an invitation to invite others to read the blog or download the e-book).
I tend to think about this power and live by it in everything I do, whether it’s learning a new language, running, teaching my kids to read, or spreading kindness.
My question to you is:
In what area of your life do you want to activate the power of compounding today?
If you liked this post, remember to recommend both the blog and the e-book Free Yourself, which you can find here.