Believe in the Power of Compounding

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“Compounding is the eighth wonder of the world.” Albert Einstein

It is said that Albert Einstein once noted that the most powerful force in the universe is the principle of compounding. In simple terms, compound interest means that you begin to earn interest on the interest you receive, which multiplies your money at an accelerating rate. This is one significant reason for the success of many top investors.

Believe in the power of compounding

The key to successful investing is patience to search and wait for great companies that are selling for half or less than what they were worth (intrinsic value), and to hold the investment for the forever. The task is to try to buy a dollar of value for a fifty cents price, and to hold the investment for the long term.

  • Compound interest is the interest you earn on interest.
  • Compounding allows exponential growth for your principal.
  • Compounding interest can be good or bad depending on whether you are a saver or a borrower.
  • Think of stocks as a small piece of a business
  • Think of Investment fluctuations, volatility, are a benefit to a patient investor, rather than a curse.
  • Focus your attention on businesses where you think you understand the competitive advantages
  • The more people respond to short term events allow patient and value investors to make a lot of money.
  • Buy stocks when things are cheap. It’s important to control your emotions.

The key is that if you spend less than you earn, you put something away, and that little something can become more and more and eventually what you want to do is you want to be your own boss.” Mohnish Prbrai

Four important factors that determine how your money will compound:

  1. The profit you earn on your investment.
  2. The length of time you can leave your money to compound. The longer your money remains uninterrupted, the bigger your fortune can grow.
  3. The tax rate and the timing of the tax you have to pay to the government. You will earn far more money if you do not have to pay taxes at all or if the taxes are deferred.
  4. The risk you are willing to take with your money. Risk will determine the return potential, and ultimately determine whether compounding is a realistic expectation.

Rule of 72

The Rule of 72 is a great way to estimate how your investment will grow over time. If you know the interest rate, the Rule of 72 can tell you approximately how long it will take for your investment to double in value. Simply divide the number 72 by your investment’s expected rate of return (interest rate).

“The first rule of compounding: Never interrupt it unnecessarily. The elementary mathematics of compound interest is one of the most important models there is on earth.” Warren Buffett

The power of compounding is truly visible with billionaire investor Warren Buffett, the Oracle of Omaha. He first became a billionaire at the age of 56 in 1986. Today, his net worth is over $100 billion at the age of 90-plus. And that’s after he donated tens of billions of stock to charity. His wealth is due to compounding, over 99% of the billionaire’s net worth was built after the age of 56.

When you understand the time value of money, you’ll see that compounding and patience are the ingredients for wealth. Compounding is the first step towards long-term wealth creation.

References:

  1. https://www.thebalance.com/the-power-of-compound-interest-358054
  2. https://www.valuewalk.com/2020/07/power-compounding-getting-rich/
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