Why Compounding is The Best Kept Secret of Investing Success

There is a stark similarity between what I reckon to be the driver of success in investing as well as superlative achievement – the single magic phenomenon of compounding.

Everyone knows that Einstein called compound interest the eighth wonder of the world.

There is also the story of the poor farmer who robbed the rich king in less than three months, when his request for a seemingly small gift of food grains starting with a single grain on day 1, and just doubling the number of grains every day was granted.

So the farmer requested that the king add 1 grain today to the first square, 2 grains tomorrow to the next square, 4 grains on the day after and so on, and thus continuing that process to so that he fills all the 64 squares of the chess board.

The rich king, irritated by the apparent frivolity of the gift, started the task only to realize by the time he had reached the 32nd square that the task was enormous.

Eventually the king gave up on the possibility of trying to fill on the 64 squares of the chess board, realizing he did not have so many grains.

That is an example of the power of compounding, and how our brain is incapable of imagining its impact.

Most people are taken by surprise when they are told that 99.5% of the current net worth of the world’s richest man Warren Buffett has been earned after the age of 50.

For compound interest to work, one needs to give it enough runway, which means start early and start with whatever is possible. Starting saving and starting it early are both important.

Secondly, for compounding to work, one needs a good rate of return over long period of time. This is not possible, unless one is wired with the right discipline and temperament to go through inevitable ups and downs of the economy and markets and keep at it.

And finally, the real effects of saving, that start looking like investing genius – sometimes simply due to the mathematical magic of compounding – will start showing only when one keeps doing it for a long period of time.

So, the key takeaway is that there are three drivers:

Start Saving Early, Increase your rates of return, and Keep at it for long periods of time.

The sad reality is very few people have planned well enough to meet all the three drivers perfectly.