As a financial concept, compounding is the art of accumulating gains on top of prior gains. Compounding happens when interest is not only earned on the initial (principal) amount, but also on the accumulated interest from previous periods.
Imagine you have a magic calendar with 30 squares representing the days in a month. This calendar offers a 10% compounded daily return. You place a dollar on the first day’s square. On day two, you have $1.10, and $1.21 on day three. By the end of the week, you have $1.77. On day nine, your money has more than doubled. By day 30, you have $15.86 — a 1,486% return, far exceeding the 300% we might assume by simply multiplying 10% by 30 days.
Most people intuitively grasp the power of compound interest when it comes to money. We understand that $100 invested monthly from age 25 to 65 will likely outperform $200 invested monthly from 35 to 65, even if the total amount invested is the same.
But we often miss how this same principle applies beyond finance. You should leverage the hell out of this concept to cultivate more than wealth.
The person who practices violin for 30 minutes daily will progress far more than someone who practices for three hours once a week. Your friend who checks in briefly but regularly likely feels closer to you than the one who makes a grand gesture once a year. Small, consistent efforts are helpful for building everything from your fitness and wealth, to your skills and relationships.
Sustained incremental progress usually outperforms large, drastic, often too-late jumps.
“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.”
~Albert Einstein
“Understanding both the power of compound return and the difficulty getting it is the heart and soul of understanding a lot of things.”
~Charlie Munger, Poor Charlie’s Almanac (Book)
