The Amazing Power of Compounding

by Daniel Ngari on January 21, 2009

Your bank thrives on the amazing power of compounding. You too can learn and apply this same power and transform your life, from your health to your finances, from your career to your relationships. Albert Einstein said “one of the most amazing phenomenon of our universe is the power of compounding”. I sincerely hope to help you draw on to this power so read on.

What is Compounding?

It has been referred to as the eighth wonder of the world. It is one of the secrets to financial freedom. According to Wikipedia, Compound Interest is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on. The act of declaring interest to be principal is called compounding (i.e., interest is compounded).

Compound InterestOur example here assumes that you invested $1000 in an interest bearing account paying you 10% p.a interest, and re-invested the interest plus the principal at the end of every period (annually) .

This means that you start earning not only on what you invested, but also on the earnings of that investment.

The power of compounding kicks in when the money is invested for longer periods. We don’t have enough space to dig too deeply, so allow me to skim on the details. If you are really interested in the mathematics of compounding jump on the Wikipedia Page on Compound Interest. I will focus on a few examples illustrating the power of the concept then jump straight into how you can apply it into your life.

I was listening to an tape by Tony Robbins and I like how he illustrated the power of compounding using the game of golf. Let us say you were playing golf with a friend decided to make it interesting by betting $1 on each hole. To make it even more interesting, you decide to double the bet amount at the end of each hole. You better be good in golf!

Power of Compounding

As you can see, the bet seems to be going alright in the first 7 holes. Its all in good fun. Then depending on whether you are brilliant or not at the game, things start changing. At hole 11, you enter into the thousand dollar mark. This is getting serious. Have a closer look at the at the luxury golf graph above to see the power of compounding.

The interesting thing to note is that at the beginning of the compounding cycle, nothing much seems to be happening. Then the small steps become adult steps, then giant leaps. You can apply the same concept in your life and get similar or better results.

Like all power, the power of compounding can be used for good or for evil. It can be used for your benefit or to destroy you. The key to harnessing this power is to understand its potency. We shall look at both the positive and negative aspects of this power.

1) Positive Power of Compounding

  • Money – You can employ the power of compounding in your financial life. As the golf example illustrates, not much may seem to happen at the beginning. But if you stay at it long enough you will see its power. You need to start investing early, and reinvesting the profits. Take a long term approach to your investment, especially if you are young.
  • Networks - You can apply the power of compounding in networking. Meet people in your profession or people who share common values. These people will then lead you to more people over time. The idea is to start early and build trust and credibility. That compounds over time.
  • Positive EnergyPlant good seeds in your brain. Fill your mind with positive thoughts. If you start early, each positive thought will manifest itself in your life and have a compounding effect. If you don’t actively fill your mind with positive messages, negativity will creep in.
  • Good Health – Keeping fit and developing proper eating habits early on will have a compounding effect on your health. If you exercise, you will have more energy to train even better. Put in the time early in life and reap the benefit through out your life.
  • Marketing – If you have a business, marketing it early and building on your successes is a great way to use the power of compounding. Instead of hopping from one opportunity to another, stick with one thing for the long haul. Deliver exceptional value to your customers and the word of mouth will propel you to greater growth later on.
  • Career – You should get experience in your chosen career and learn skills to help you do your job better. As you become better at one skill, it becomes relatively easier to acquire subsequent skills. Most people give up trying to improve themselves too early. Don’t give up. Have a plan and stick with it even when the going seems tough.

2) Negative Power of Compounding

  • Credit Card Debt – You must understand the time value of money. If you are spending money you don’t have, you will end up paying a lot more to the banks over the years. You may be tempted by fabulous offers but please think of the future.
  • Bad Habits – Bad habits such as drugs and alcohol can also compound. You start slowly and find your self having a bit of this and a bit of that, then a bit more. Before you know it you get hit by severe consequences. You may not have big bad habits like drugs, but there are other bad habits such as procrastination and lies that can compound and overpower you.
  • Pyramid Schemes – A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, often without any product or service being delivered. Sellers of pyramid schemes may sell you the benefits of their scheme and even throw in tips about the power of compounding as applied to their scheme. You have been warned, pyramid schemes end up hurting people. If it is not you, it may be the people who you recruit into such schemes.
  • Negative Spirals – In the same way there are positive spirals, you can get entwined with negativity. Each negative thought or friend brings in another. You may end up being a very negative person if you hang out with negative people. Hang out with positive people instead, read positive stuff and watch stuff that motivates you instead of putting you down.

Summary

There is power in compounding, you need to understand the concept and employ it to serve you. Take a long term approach in your wealth, health, networking and business. Patience and perseverance at the early stages of life or investment will take you to the promised land called success.

All the best in your success.

P/s – I added a share this button on the site today (see below). If you find this blog interesting or even a particular post useful, please consider sharing it with your friends on networks such as Myspace, Facebook or even by email. Thank you my friend.




{ 5 comments }

Doba March 11, 2009 at 6:32 pm

Compounding. Yes!

Marto February 20, 2009 at 4:22 pm

just browsing past the articles but this one realy caught my eye , as an aspiring writer have to give u mad props

paula January 22, 2009 at 8:58 pm

As I go through this post I am reminded of mathematics one of my favourite subjects. Investing is vital if one wants to prosperous life. Daniel thanks for showing me that I can invest in any area of life. Looking forward to more of this..

Nyomi January 22, 2009 at 8:12 pm

I’m inspired! Another excellent article, Daniel. I’ll invest in compounding in more areas of my life.

I’m looking forward to reading more articles, dude.

Cheers,
Nyomi

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