He Who Understands It Earns It, He Who Doesn’t… Pays It

How compound interest influences your whole life, and not just with money…

In this article, we will look at the different parts of our lives where compound interest is at work, and it’s a mistake to think it’s only with money.

The result of our lives depends largely on how well we understand how compound interest works

In one of my latest posts, I refer to a free downloadable book in which the author talks a lot about compound interest. After pondering on this for a while I started to realize that the result of our entire lives depend on how well we understand the workings of compound interest.

“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things”

— Charlie Munger, business partner of Warren Buffett

There are 5 main life categories we are going to talk about, even though it applies to almost every category you can think of. Here is a shortlist for the topics:

1. Money
2. Relationships
3. Mental strength
4. Physical strength and endurance
5. Education

Money

According to Investopedia:

Compound interest (or compounding interest) is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods.

This means that the reward on something of value, like money, stacks on top of the previous reward, resulting in an even bigger reward. The next reward will be even bigger, etc..

With money it is easy to see how you can make this work in your favor:

Let’s say you buy $1000 worth of stocks, which, on average, have a return of investment of 15% per year. After one year you would have $1150 worth of stocks. In the second year, the return will be $172.5 and compared to the return of $150 of the first year, this is a $22.5 higher return.

If you keep your money in the stocks for 10 years, while interest stays 15% per year, this means that after this period of time your stocks will be worth $4045.56(!). This is more than 4 times as much as you invested in the beginning, and it shows the power of compound interest very well.

To make the power of compound interest work for you, one can start by investing a small amount of money, that you of course can afford to lose, and see the value increasing by bigger and bigger steps each year.

“Compound interest is the eighth wonder of the world.

He who understands it, earns it. He who doesn’t.. pays it.”

— Albert Einstein

Relationships

It is not well known that compound interest plays an important role in the bonds people build up with each other. Let us define compound interest in the following way:

The building up of something small into something bigger. At some point, the ratio of energy or value that you are putting in compared to what you are getting back for it is much better than before. As your buildup time gets greater, the returns you gain are getting better and better, and even disproportionate of the effort you are now putting in.

With money in a savings account, that’s easy to see. With relationships, however, this power is at work as well.

Making new friends is fun and all, of course, but when you are going through tough times, it is often the friends we have known the longest that are best able to help us. Because of a long friendship, that you have both deposited effort and time into, you have gotten to know each other inside out. You share countless experiences and are more likely to be able to be of help.

These are things that one would normally not think about when speaking of compound interest, but that doesn’t make it less real. Think about it,

When you keep investing in someone and that other person does the same thing, what is possible to build up is hard to overestimate.

“Building and repairing relationships are long-term investments.”

— Stephen Covey, author of Seven habits of highly effective people

Mental Strength

Mental strength is more of a habit than it is a character trait set in stone. By practising courage, for example, you make little acts of bravery. After some time, you will dare to do things you never thought you would have the courage for.

For example, take a look at public speaking:

The majority of people, 75% to be precise, rate public speaking as the thing they fear most. People fear it even more than death itself(!). Now imagine you would take every opportunity available to practise courage and speak out loud, to whoever might be listening.

When being with your friends, you speak up when you have something to say.

When you are in line at the checkout, you start a little chat with the next person in line.

When it’s someone’s birthday and you sing happy-birthday, you sing a little louder than you would normally.

Over time, you will learn that there is not much to be afraid of, and you will even find yourself able to speak out loud when you are in a group. You would have never been able to get this result in the beginning, but after building something up over time, the reward becomes out of proportion to what you are still putting in.

Now you can do something you never held imaginable before.

“All the great speakers were bad speakers at first.”

— Ralph Waldo Emerson

Physical strength

Building physical strength and endurance, let alone building muscle, does not happen overnight. Working daily towards a stronger and more healthy body is probably the best investment you can make.

The best reason to start today building up what you can only build up over a long period of time, is well captured by a quote from the inventor of the Pilates method of physical fitness.

“Physical fitness can neither be achieved by wishful thinking nor outright purchase” — Joseph Pilates

The only way to have the body of your dreams is by working on it today, and then again tomorrow. When you have achieved your goal, you can maintain a great physique with relatively little effort: a result you can only get by little consecutive improvements over time.

“The best time to plant a tree was 20 years ago, the second-best time is now.”

— Chinese proverb

Education

In the free downloadable book I talked about earlier, the author talks a lot about educating oneself. He also talks about how gaining expert-level specific knowledge gives you a huge advantage over your competition.

For example, look at a job as a software developer:

When you start out in a junior position, with no prior experience, you will earn roughly around $20–25 an hour. With about a year of experience that rate will go up to about $30–35 an hour.

With three years of experience, however, when you are getting closer to mastering the art of a programming language, you can expect to earn $100 per hour.

The rate of increase in your salary doesn’t come from becoming that much better anymore. The huge leaps you are making in salary are coming from getting 2–5% better and so getting more skilled than most other software developers. When you are at the top of your market you can expect to earn a disproportionate amount of money for the amount of work you are putting in, compared to what you would earn just before reaching the top of the market.

The same logic applies when you are a scientist about the amount of influence you have in your field, or being a soccer player getting a disproportionate amount of recognition, fame and money for being slightly better than the rest.

This may be best summed up with the Pareto distribution, otherwise known as the 80/20 rule. This says that most of the rewards are lurking at the far end of the spectrum.

“Strive for excellence in a few things, rather than good performance in many.”

— Richard Koch, author of the 80/20 principle

Summary

The rules of compound interest apply almost everywhere in our lives, and to pick the fruits of it we need to be aware of where it is at play. Playing the long game is almost always the most rewarding option.

Keep in mind that the fruits will only come later, but if you play the long game, the feast will be fruitful for sure.

“The day you plant the seed is not the day you eat the fruit.”

— Fabienne Fredrickson

Plant one seed and compound interest together with time will return you 100 apples.

Thank you for reading. If you are also interested in my most successful articles, check them out here!

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