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
more 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 stock
market (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 utilized 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.
The Money Gym specializes in working with bright, intelligent people
who want to become financially free, learn how to build a business they
love and invest for a safe and fulfilling future.
