Compound interest and the value of playing long term games.

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“Compound interest is the eighth wonder of the world.”-Albert Einstein

Compound interest has been hailed as one of the wonders of the world and rightly so because of its potential to astronomically create value way more than what was put in. 

It's one of the surefire ways of managing and growing your money and other aspects of your life as you will get to see.

I believe in cross-disciplinary learning so I'm going to be drawing parallels from the principles behind compound interest in the context of maths, financial and money setting and then apply them to our everyday decision making and lives.

To do this, I'm going to be very obvious here and explain compound interest briefly so that how it works is clear to everyone and you can understand why I have chosen to use it as a framework (please pardon me, finance gurus). 

Compound interest is a process of growth much like the snowball effect; a process that starts from an initial state of small significance and builds upon itself, becoming larger. It's not a linear growth but rather exponential/geometric growth. 

Here is an example of how compound interest works in relation to your money. 

If you deposit $100 into your bank and the annual interest on your principal (the $100) is 5%, here is what happens:

Year one - you would gain $5 on your $100 and therefore have a total of $105.

Year two - here is where the magic begins. You earn 5% on your $105 which is $5.25 so you now have a total of $110.25.

Year three - 5% on your $110.25 is $5.51 getting your initial $100 to $115.76.

Let’s draw this out a bit into the future, by year 10 you have $168.89  and by year 20 it’s $265.33. See how your humble $100 could become a behemoth?

Of course, all this depends on if you are adding to or withdrawing your money within this period. The above example is based on the assumption that you kept the $100 there and forgot about it.

There are a lot of resources online to help you understand compound interest better, this video is a good place to start.

The main things I want to highlight here that makes compound interest so powerful are:

1.    The time factor. For compound interest to really make sense it has to be a long-term play.

2.   Consistent effort. The interest 5% in the example above was consistently added over the period.

Now that I have gotten the financial context out of the way. Let me get to the point, which is layering on these principles; consistent effort over a long time, onto other aspects of our lives.

Naval Ravikant, the renowned angel investor aka angel philosopher, is one of the people that have shaped my thinking and outlook on life has this to say about compound interest and its life application.

“All the returns in life, whether in wealth, relationships, or knowledge, come from compound interest".  

What I find interesting about the principles of compound interest is that it’s consistent with the universal principles of success: time and consistent efforts.

There is no such thing as an overnight success. Take a minute to think of anyone you know that has achieved something significant, whether in their career, relationship, business etc. You will see that time and consistent efforts are the reoccurring themes.

Serena Williams, Elon Musk, President Obama come to mind for me.  Michelle Obama’s enviable arms weren’t “built” in a day.

I don’t want to restrict this to just career even though that seems to be the most obvious examples. Think of couples that have enviable relationships or people that have raised well-adjusted and happy children.

It takes consistent effort and thinking long term.

I’m using these principles as a directional compass to decide the types of things I want to see in my life in the long term; the types of relationships I’m nurturing, the types of projects I’m taking on, the skills I’m developing.

It’s yes for things I want to compound and no for those I don’t.

I ask myself what long term benefits I will be getting from this that outweighs the current time commitment. The benefit has to tilt the balance.

Minimal effort < Great reward. 

I’m not saying stick to something that doesn’t work. I had written about the sunk cost fallacy and how people tend to stick with things that don’t work because of the time and effort they have invested. You can read the article here.

What I’m saying is that you need to give things time and stop when you are sure it isn’t working or the results aren’t what you want to see on a larger scale years into the future.

Also, be aware that while I’m using the benefits of compound interest in the positive light its effects are the same in the opposite direction; think about how bad loans can become larger than life or how bad behaviour or vices can quickly spiral.

Or how lack of communication or investing in your relationships can create a massive gulf and you can barely find your way back to each other.

Its impact can be positive or negative. 

To apply these principles to your life, first think about what is most important to you in life (relationships, health, spirituality, family etc.).

How you want to use your time or how you want your life to unfold. Then start consistently spending time on these things.  

The growth here is never linear.

Time activates compound interest so you need to be in there for the long haul to see the benefits. If you are one year into that project and you are wondering how this is ever going to materialize into something great. Just keep showing up and consistently putting in the work.

The regular and consistent "one minute" you spend with a loved one doesn't have a "one-minute" impact on your relationship over time it equates to a deeper connection that probably rubs up positively on other aspects of your life. 

The “15minutes” you spend daily exercising has a multiplier effect on your life years into the future. Same as the time you spend learning something new. The new knowledge isn't directly proportional to the time spent. 

Compound interest could also be used as a filter to decide what you want to commit to. 

If your use case for example is a relationship, ask yourself do I see myself with this person for the next 10 years.

Do I want to create a snowball effect here? Do I see myself doing this thing or living this lifestyle in the next 10 years? 

In closing, I will say let's all be "bad' at maths, let our 1 + 1 never be 2. It has to be at least 3+. Seek out force multipliers in every aspect of your life, be consistent and think long term.

Happy Zigzagging,

Ije.

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PS: I’ll every once in a while, recommend books, articles, videos and podcasts that I think you will find useful.

I’m starting with Naval Ravikant.  Like I said earlier he has been very instrumental in shaping my outlook on life.

Here are some resources on him:

1.   The Almanack of Naval Ravikant: A Guide to Wealth and Happiness: is a compilation of all his tweets and podcast interviews (I own the e-book and physical book. This is my most referenced book. It has more wisdom per page than any other book I have read). You can download a free epub or pdf copy here. Thank me later.

2.   His podcasts can be found here