The Concept of Compound Interest

Compound interest is something we associate with finance. The more we save the more we can invest. This leads to compounding interest overtime and is the basic concept for retirement savings. If you are saving for your child’s education, the concept of compound interests allows you to save now so you have more for their education in the future.

I don’t think compound interest just applies to your finances. I think it applies to all aspects of life from knowledge to health. In this article I will be exploring this. I think understanding compound interest is one of the keys to life. Anyone who has either lost a lost or gained a lot of weight will tell you that it didn’t happen in one meal. It happened over the course of time. It happened by developing good or bad habits.

Habits and Compound Interest

You could have guessed that developing habits plays a major role in whether compound interest will work for or against you. In order for compound interest to work for you. You need to develop healthy and consistent habits.

Exercising for one day will not improve your life. You may get the initial rush from completing your first workout. But if you don’t continue the habit, it will have no benefits in your life. The act of working out daily or getting on a workout routine will improve your life. It makes compound interest work in your favour. The accumulation of little events combining over time to produce big results.

I’ve talked in previous articles about developing habits. I won’t go into much deal here. Habit formation is the act of doing something consistently. You need to develop things into lifelong habits for you to produce dividends in life.

Since I just used the word dividends, let us use the example of stocks to explain compound interest. Buying one stock won’t increase your net worth by much. Even if this stock rises to 10x the initial purchase price more than likely this won’t make you rich. Although if you purchase one stock every month over the course of a lifetime. This stock then may eventually rise to increase your net worth. If this is a dividend paying stock and you reinvest the dividends this will also increase your net worth. You have two habits that contribute to a healthy use of compound interest. The first is purchasing stocks monthly, and the second is reinvesting the dividends. This is a formula for success. Note I’m not saying that buying one stock a month will make you rich. And I’m certainly not saying invest all your money in one company. What I am explaining is the act of forming a habit of investing money so compound interest can work in your favour.

Exercise and Compound Interest

If you have read my previous articles, you have noticed I mentioned exercise as one of the fundamentals to life. I truly believe this. Although what makes exercise a beneficial part of life is putting together multiple work-outs days in a row. This is how the compound interest principle applies to exercise. Like I said above working out once isn’t much of a benefit to you. Although if you manage to form working-out into habit you will see benefits.

Let us use the example of running. Today you go for a run and can only run for five minutes. After those five minutes you are grasping for air and need to stop. For many people this is discouraging. It makes you want to quit before you even start. But if you use the concept of compound interest this may make things easier. The next day you don’t quit, and you run for 30 seconds extra. This doesn’t seem like much, but you are starting to use compound interest in your favour. If you can manage you increase your running time by 30 seconds for 110 days this will allow you to run for an hour straight. Most people would find this difficult. You just used compound interest to your advantage.

The above example addresses how you can accomplish multiple things though the use of compound interest. You have increased your overall fitness level, you have increased you running time, and you have developed a healthy habit. Start small and add over time. Let compound interest do the work for you.

Knowledge and Compound Interest

You can’t talk about knowledge and compound interest without referencing this famous quote by Warren Buffett:

“That’s how knowledge works. It builds up, like compound interest. All of you can do it, but I guarantee not many of you will do it.”

It’s a pretty simple concept the more you read and learn. The more knowledge you accumulate. This is why the most successful people in the world are huge readers. There thrust for knowledge is greater than others. Over time the knowledge they acquire builds to an understanding of the world others don’t have.

I have talked about common sense before in a previous article. By using compound interest to develop your knowledge you are basically increasing your common sense. You are developing a basis for making better decisions. Which in turn leads to a better life. Better decisions make for a better life. Shocker I know!

The 10,000-hour rule

I just started reading Malcolm Gladwell’s book Outliers, and I cannot put it down. But this isn’t a post to talk about Gladwell’s great book. What I am addressing here is Gladwell’s concept of the 10,000-hour rule which relates to this article. The 10,000-hour rule is fairly simple; in order to master in a certain craft whether it be sports, music, or writing. You need to invest 10,000 hours to become an elite performer. There is no doubt you need a certain skill set to master a craft. If you have no aptitude for painting but you spend 10,000 hours painting. You may become a better painter, but you won’t become a great one. What I refer to as compound interest. Gladwell refers to as the 10,000-hour rule.

I was listening to a Tim Ferriss podcast with Jerry Seinfeld as Tim’s guest. Tim was interviewing Seinfeld about the art of writing and the comedy craft as a whole. When they start getting deep into what makes a great comedian. Seinfeld refers to comedy as being a craft of “tonnage.” Seinfeld basically means the more you perform and write the better your will become at the craft. To become a great comedian, you have to put in your reps on stage. Whether you are performing at the famous LA Comedy Club or in a strip club basement. You need reps to become an elite performer. To become the best at something you need to put in the work. Again, what Seinfeld refers to as “tonnage.” I am calling compound interest.

Let us get back to Gladwell’s book Outliers. Gladwell tells a great story about The Beatles. Most people would consider them the greatest band ever. When The Beatles started playing they were not the best band. Not surprising. No one is the best when they first start. When playing in England they could only find gigs allowing them to play one-hour sets. In Germany there were no rock clubs they only had strip clubs. In Germany’s strip clubs, you had to play all night. The Beatles started playing in these clubs.

Over the course of a year and a half; The Beatles played over 200 shows playing for a minimum of 5 hours a night. And in this time, they mastered their craft. Five times two hundred do not equal 10,000, but you have to consider the amount of time they spent practicing. Learning a new song takes time and effort. And learning enough songs to fill a 5-to-8-hour set is extremely difficult. Clearly each of The Beatles was extremely talented and had huge aptitude for music. But the time they spent in Germany playing at strip clubs certainty contributed to their success.

As you can tell from the examples, I used in this article. Compound interest is a major factor in success. No one gets out of bed; decides to play in the NBA and it just happens. It takes hours and years of practice to prefect any craft. To become great, you need hours of practice at your craft. Whether this time is accumulated though formal education or through practicing alone. I don’t think it matters. The key principle is to practice and practice the correct way. Let compound interest work in your favour and over time you will see results.

Compound interest is something I have been studying for some time. I first came across the term because of my interest in finance. I slowly started realizing this maybe the most powerful concept in life when used to our advantage. If you are interested in learning more about compound interest and habits subscribe to my website. Or look me up on Instagram @the_52_book_challenge. Check back next week for my next post!

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