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Compounding is often described as the ninth wonder
of the world. It is a concept that initially sounds
quite dull, but when you understand how compounding
just quietly works its magic - or conversely its
naughtiness - it's a very exciting concept to
grasp indeed!
Compounding is the difference between linear and
exponential growth, or put more simply, about
earning (or incurring) interest on the interest
on the interest, generated by your savings (or
your debt). On an energy level, it's about making
sure that every little bit of effort you expend,
works on many different levels to bring a reward
greater than the original effort required.
It's a very powerful tool and can be likened to
the wind under the wings of a jet. The plane creeps
slowly, slowly along the approach runways, then
moves into position, then starts down the runway
slowly, but as it picks up speed, the power of
the engines and the wind lifts its wings and it
takes off, climbing very quickly and steeply into
the sky.
Compounding can turn just one - just one - £1 or
$1 into a million pounds or dollars within 20
years. If you took £1 or $1 and achieved a 100%
return on your money each year (put another way,
if you doubled your money each year) then you
would most certainly be a millionaire in your
lifetime. Imagine if you added another £1 or $1
each year - how much faster would that get you
there?
And if compounding is that powerful when applied
annually, how much powerful could it be when applied
monthly or even daily?
On a personal finance level, most people ignore
the potential of compounding, because the % interest
rates we are quoted by the banks, other savings
vehicles and financial institutions are so paltry.
If you took your pound or dollar and increased
it at the usual 3% or 4% per annum, then it would
grow so slowly that we might as well not bother
saving at all. You would be dead several times
over before your personal wealth increased noticeably.
I know I used to feel like that! Why save now,
I thought, especially when you are only saving
to spend later, and when you can only earn 3-4%
per year on your savings? I want to share with
you, today, some of the exciting things that I
learned about the power of compounding, things
made a huge difference to my thinking about money.
And changed me from a non-saver to an investor
in one fell swoop!
There is a huge difference between saving and
investing, and experienced Investors achieve returns
on their money between 30% and 100% per annum
- some even manage to achieve an infinity return
on their investment, because they are able to
pull their own money back out of the deal, which
means that they are making money with no money!
These are the supermodels of the investment world!
On a personal finance front, even looking at the
returns generated by investing in property over
the years (12% per annum) and the stockmarket
(14% per annum) gets a little more exciting. The
compounding effect means that, on average, property
doubles in value every 7-10 years - that's a thrilling
thought! How would you plan your property investment
differently if you knew that to be true?
There is a great example of the difference in
what you can achieve in just two years, if you
invest £60,000 (or dollars! I'm going to work
in pounds now but the principle is the same!)
by buying outright one small rental unit, versus
what you would achieve if you invested the same
£60,000 in deposits on several small rental units.
At the end of the two years, if you just bought
the one unit, and assuming average rates of growth,
you would be worth £6384 more than when you started.
But if you invested in deposits on several units,
you would be £56,304 better off. You choose. That's
compounding at work.
On a business level, compounding can work for
you too. The difference between what you can earn
if you are a solo self-employed person, and what
you can earn if you build a business consisting
of a team of "you's" is quite amazing.
The compounding effect can also be utilised in
your business by automating as many of your business
processes as possible. Think of the potential
difference between having the services of one
marketing person and one sales person (both of
whom can only work so many hours in a day, both
have to be paid, even when they are on holiday
or off sick, so not working) and then consider
the possibilities of having an automated marketing
machine working 24/7 plus a team of affiliates
- unlimited numbers of independent people who
are all being paid a little bit, on sales (results
only!) to promote your service or product.
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