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I’VE ALWAYS BEEN fascinated by compounding. I discovered the concept at a young age. The idea of money making money was earth-shattering to me. Do you mean to tell me I don’t do any physical work and the money just grows? Yes, and—with enough time and interest—it can grow at lightspeed.
I was all in. I searched for everything I could on the subject. This is where my love for financial planning began. I wanted to follow all the rules of compounding: save early, save often and never interrupt compounding unnecessarily.
In case you aren’t sold on just how amazing compounding is, let me give you an example: the wheat and chessboard problem. Imagine a chessboard. Picture one grain of wheat on the first square. Now, imagine that grain doubled with each subsequent square as you moved through the board.
You’d have two grains on square two, four grains on square three, eight grains on square four and so on, until the entire chessboard was covered with grain. How many grains of wheat would be on the board? I have no idea what number you have in your mind. All I know for certain is that it’s incorrect.
The answer is 18,446,744,073,709,551,615 or, phonetically, eighteen quintillion, four hundred forty-six quadrillion, seven hundred forty-four trillion, seventy-three billion, seven hundred nine million, five hundred fifty-one thousand, six hundred and fifteen.
When it comes to financial planning, compounding has obvious benefits. The more money you save early and often, the more time it gets to grow. After lots of time, it grows exponentially. Conversely, high-interest debt—notably credit card balances—will hurt you over time. Indeed, given enough time, it can hurt you exponentially.
I don’t think compounding is limited to money. I believe everything compounds.
Take your diet. If you eat one donut, are you unhealthy? If you eat one salad, are you healthy? Of course not. But with enough repetition over time, either of these meals will change your health for better or worse. In fact, after a long time, you could be extremely unhealthy or extremely healthy. By committing to the daily habit of eating right, you can supercharge your health over the years.
The same is true of physical fitness. One run doesn’t make you fit. One weightlifting workout won’t make you strong. But compounded over time, you can get to a level of fitness and strength that, at the outset, you would’ve never thought possible. Conversely, taking a day off from your workout won’t hurt you. But over time, routinely skipping workouts will cause you to lose fitness and strength.
Relationships work the same way. You and I will not become best friends from our first encounter. We may not even be best friends after our fourth meeting. But if we spend lunch together once a month for the next five years, we’re going to be intimate confidants by the end.
Similarly, if I choose not to speak to a family member except on holidays, our relationship will deteriorate. Not the first year. Maybe not even the second year. But the odds are, we’ll both look up in 30 years and wonder what happened. Compounding is what happened.
An old saying sums it up nicely: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
Your habits will compound. The only question is, are you earning compounded gains—or paying a hefty price?
Luke Smith is a CFP® professional and practicing financial planner. He creates customized financial plans for each family he works with around the country. Luke pursued financial planning to combine his two favorite passions: finance and people. He spends his free time with his wife Heather and their family in Maryland. Outside of work, Luke enjoys the outdoors, golf, reading and writing. You can reach him at Luke.Smith@Wealthspire.com. His previous articles were Can’t Stop Themselves and Moving the Goalposts.
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what you are describing is an exponential increase 2^n rather than simple compounding.
I wouldn’t agree at all that relationships compound, and intimacy is not at all the goal for all relationships.
But great view on compounding. But I think to get the full benefit in the mind requires meaningful examples that people can relate to. Especially for kids. Have them walk through the compounding process with the classic start with a penny and doubling for a month thing. A chessboard and quintillions is weirdly abstract.
Have them pick up a calculator and show them how by just starting with .01 and hitting the ‘=’ repeatedly, with each press of the key being a day and have them count to 30 while watching the number. It’s not just that it compounds to a big number. It’s seeing it happen with numbers they can grasp and thinking through the implications of those last few days. A light bulb may go off for them, or at least the idea will stick and maybe later they’ll think about it when investing.
Thank you for a much-needed reminder of the power of compounding.
I’d like to mention another item that compounds to our detriment: inflation. Inflation also compounds as every year’s price increases build on price increases from the previous year.
The only way to counter the corrosive effects of inflation and build wealth is to earn a positive, real (inflation-adjusted) return on your investments over time. Compound growth is an effective way to do this.
I heartily agree with your admonition to not unnecessarily interfere with compounding when making investment decisions.
Thanks for the reminder of the power of compounding and that it can be applied to areas of our lives outside of investing.