This is an except from Mind Macros 06.
In finance, compound interest refers to interest on an initial investment. If we invest $1,000 into the S&P 500, by the end of a year, it will have become $1,100 with a 10% return rate. Using the same return rate the following year, the initial amount becomes $1,210. The interest gain is reinvested rather than withdrawn. With time, the principal sum snowballs into a much larger amount. After 50 years, the figure becomes $117,390. If, however, we continue to invest $1000 every year, after 50 years, the end balance would be $1,397,690.
“More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay enough attention to the simplest fact: Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child. As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s.” — From The Psychology of Money by Morgan Housel.
Compound interest has undeniable power in finance. However, its application reaches far beyond wealth generation.
“It is so easy to overestimate the importance of one defining moment and underestimate the value of making small improvements on a daily basis. Too often, we convince ourselves that massive success requires massive action. Whether it is losing weight, building a business, writing a book, winning a championship, or achieving any other goal, we put pressure on ourselves to make some earth-shattering improvement that everyone will talk about. Meanwhile, improving by 1 percent isn’t particularly notable—sometimes it isn’t even noticeable—but it can be far more meaningful, especially in the long run. The difference a tiny improvement can make over time is astounding.
“Here’s how the math works out: if you can get 1 percent better each day for one year, you’ll end up thirty-seven times better by the time you’re done. Conversely, if you get 1 percent worse each day for one year, you’ll decline nearly down to zero.
“The same way that money multiplies through compound interest, the effects of your habits multiply as you repeat them. They seem to make little difference on any given day and yet the impact they deliver over the months and years can be enormous. It is only when looking back two, five, or perhaps ten years later that the value of good habits and the cost of bad ones becomes strikingly apparent.” — From Atomic Habits by James Clear.
Success is less herculean and more like laying bricks. The bricks represent our 'daily disciplines,' the habits we are unwilling to compromise on to achieve our goals. Every action we take is a brick laid on the foundation of our future.
Consider what the habit will compound into as you develop a routine, rather than how it will look on a day-to-day basis. Small daily actions will compound into extraordinary results.
Compound interest does not map exactly the same way with habits as it does with finances, but the underlying principles remain the same. The greatest benefits come at the end, not the beginning, which is why compounding is not intuitive. We're exercising delayed gratification, putting in the effort today to reap the rewards in the future.
When trying to predict how our life will look in the future, Clear suggests imagining what the compounding results of our current actions will be:
“If you want to predict where you’ll end up in life, all you have to do is follow the curve of tiny gains or tiny losses, and see how your daily choices will compound ten or twenty years down the line. Are you spending less than you earn each month? Are you making it into the gym each week? Are you reading books and learning something new each day? Tiny battles like these are the ones that will define your future self.”