The Counterintuitive Power of Compounding

We are bombarded by compounded events throughout our lives.

The universe runs on the invisible force of compounding - Stars and galaxies form through exponential chain reactions, Life begins from a simple single-celled organism to a complex trillion-celled live being. Even today’s technologies are a result of decades, perhaps centuries of compounding, whose benefits we have just started reaping.

But let’s zoom in on us ourselves. A lot of things that play an important role in our lives run on this powerful force too, whether it’s our health, money or even our career, all of it grows on the exponential curve.

Yet we don’t even realize it!

Because ironically, our brains are not designed to grasp such important events intuitively.

Intuition is a miracle of nature. Every living being has a natural, ‘intuitive’ intelligence that helps them survive in this world. Intuition doesn’t need past data and learning, it’s just there within us, a way of doing stuff which we may have never done before, yet we ‘know’ how to do it… it’s absolutely amazing!!

But something like compounding, as mentioned earlier, is not intuitive to us, and there are reasons for it- we are naturally linear, short-term thinking folks…

Let me explain.

We like to see a relation between any two things as having some sort of fixed direction- “If I study for longer hours, my grades will improve, therefore I must study for longer hours” or “I feel good when I eat aloo bhujia, therefore I should keep on eating to feel better”.

No, things don’t work like this, studying for hours is good but too much of it obviously reduces your productivity, and yes, I feel really, really good when I eat aloo bhujia, but I will stop feeling good after a certain point and worry about my goddamn health!!

Relations like these are rather non-linear in nature, there is a point of maximum gain/satisfaction, and then there is a dip rather than a continuous upward slope

The second, important point of us being short-term thinkers has got to do with our physiology.

The human brain is remarkable, but its physiology has not evolved for the modern society we live in. We have the same brain as our ancestors had 2,00,000 years ago! What this implies is that we still share certain psychological traits with our ancestors, the major one being thinking in absolute short-term.

Our ancestors were on a constant survival mode. They had to be safe from big, wild animals, had to secure a meal for the next day and just respond to other immediate threats. They lived in what scientists call an immediate-return environment, and even though we don’t live in such an environment today, we still crave for instant gratification and immediate rewards, whether that’s through social media, junk food or gambling… you get the idea!

So why am I elaborating so much on these points?

Because compounding is also just made up of two things, though in the exact opposite way:

Compounding is a non-linear, long-term concept.

“OK, so you have explained what compounding is (or is not), but how do I utilize it?!”

Fine, here we go…

Compounding Wealth

Here is an interesting fact- $81.5 billion of Warren Buffett’s $84.5 billion net worth came after his 65th birthday, that is nearly 96% of his current wealth!!!

This kind of thing sounds so absurd to us, but for a guy like Warren Buffett, this was always obvious simply because he knew the power of compounding.

Yes, Warren Buffett is a skilled investor and might know a lot of things better than others, but so did countless other people in the game who didn’t make as much money as him, the difference wasn’t having better trading strategies or smarter people at his disposal, it was just keeping and growing his money marginally for the past three-quarters of his life, or as Morgan Housel rightly says-

There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called Shut Up and Wait!

This seems pretty obvious in hindsight, but had you lived in the age of the 20th century, any rational person would have taken out his money at various points in time as this phase was marked by an economic depression, two World Wars, a Cold War, multiple recessions and thousands of other problems…

Yet the market always won, and so did Warren Buffett… He just let the force of compounding do its magic!

Compounding Trust and Relations

There is a wonderful chapter in The Almanack Of Naval Ravikant dedicated to compounding.

In that, Naval believes that all returns in life come from compound interest, whether it’s our relationships, wealth or knowledge. He emphasizes on the point that it’s important to build strong relations and a good career portfolio in order to gain the trust of the people.

This is not a short-term thing though, a strong reputation comes only after years, sometimes decades of building relationships and trust, but your value increases- companies and the society in general value you more because they trust that you will do well for them and are even ready to forgive some of your mistakes- they are ready to take on some of your risk, and your worth multiplies by a thousand times…

It gets compounded.

Play long-term games with long-term people

— Naval Ravikant

Compounding Habits

James Clear’s book Atomic Habits is a goldmine of knowledge when it comes to human potential.

In the book, James talks about how humans overestimate the importance of one defining moment in their lives and underestimate the value of small improvements on a daily basis.

So, when we want to lose weight, learn to code or write more, we feel the need to make some huge improvement in a very short period- “I’ll lose 10kgs in one month” or “I’ll learn R and Python within this semester” or “I must write 10 long articles within the week to grab people’s attention”.

But having a goal-oriented approach like this usually doesn’t work because improvements take time, and since we are ultimately creatures craving for immediate rewards, when we don’t feel the improvement, we quit and slide into a negative, stagnant path.

The author has a clear solution for it.

Try to improve marginally every day for a year, however small the improvement. It’s a painfully long process, and you won’t see the results for days or even months, but good habits compound over time, and before you realize, those habits become a natural part of your life, rewarding you with exponential gains.

Habits are the compound interest of self-improvement

The 1% rule of compounding:

Compounding Knowledge

I once watched a conversation between the musician Paul McCartney and The Late Show host Stephen Colbert.

In that, Colbert asks him how did he write these immortal lyrics? Where did it come from? And why aren’t there more like him in this world?

To which Paul says that he was born in a musical family, and that right from the beginning, he was surrounded by his parents and relatives who loved playing different songs during parties and other events.

He compares his brain to a computer, which was in a sense ‘downloading’ all of this subconsciously throughout the years, and when the time came for writing down new songs for the Beatles, all these bits and pieces just ‘printed’ themselves out in a beautiful, unique way - as if almost magically!

That ‘magic’ is nothing but the compounding of knowledge and ideas. As I wrote in my previous essay about the power of mathematical thinking, learning takes time and doesn’t reward you immediately - its effects are seen only years later, when different streams of thoughts and ideas combine in your mind to solve a unique problem… or to create a new song! All of it works in the same way.

It gets compounded.

That’s how knowledge works. It builds up, like compound interest

— Warren Buffett

Conclusion

As I write this, I realize that I too am living in the process of compounding. My writing may not be up to the mark now, but it’ll be better if I just keep on writing consistently, every day for the next 365 days.

Similarly, my ideas are getting compounded as I read daily and try to make sense of the world by combining all that I have read, into a post like this!

So, by now you know the power of compounding, and the role it plays in literally everything we do…

Master that power, and the world will be yours my friend!

---

I have tried to combine a lot of ideas mainly from some of the books that I read, and while I have mentioned the book and the author wherever I could, I am still learning the art of referencing, so until that time, I request you to click on the links given below, they’ll lead you to the books that inspired me to write this post, and please read all of these whenever you get the time, it’s absolutely worth it!

1) https://www.amazon.in/Almanack-Naval-Ravikant-Wealth-Happiness/dp/1544514220

2) https://www.amazon.com/Atomic-Habits-Proven-Build-Break/dp/0735211299

3) https://www.amazon.in/Psychology-Money-Timeless-lessons-happiness/dp/0857197681

4) https://www.amazon.in/How-Not-Be-Wrong-Mathematical/dp/0143127535

---

Today I’ll leave you with only one additional link- It’s the savage Chamath Palihapitiya explaining how slow compounding works (Warning: includes A LOT of cuss words, basically typical Chamath😅😂)

1)

and the whole talk-

2)

Do share this essay if you liked it and let me know what you thought of it!

Cheers!