Compound Effect
Master the strategy to play the long-term game
“Compounding is magic. Look for it everywhere. Exponential curves are the key to wealth generation.“ - Sam Altman
What Is Compound Effect?
For simple understanding, compound effect is the principle that small, consistent choices, behaviors, and habits, when repeated over time, lead to significant results and outcomes in various areas of life.
Compound Effect = Choices + Behavior + Habits + Time
It is the strategy for reaping huge rewards from small changes which requires patience, responsibility, and accountability.
Why Is Compound Effect Important?
It is a powerful concept that can have a significant impact on all areas of our lives, whether finance, learning, expertise, or relationships. Simply put, the compound effect is the idea that small, consistent actions taken over time can result in significant growth and improvement in the future.
Finance is the field where the value of compound effect is most obvious, as demonstrated by compound interest. Albert Einstein had a famous saying: "Compound interest is the eighth wonder of the world". The true power of compound interest lies in its ability to generate significant growth over time, even with small, incremental investments. Though the effects may not be immediately noticeable, over the long-term, compound interest can lead to substantial financial gains.
Let’s look at three below charts to understand more the power of compound interest.
1. Power of compound interest
The power of compound interest is clearly demonstrated in this graph. When Susan retires at age 65, she has a higher net worth than Bill, who has invested his entire life, despite only having invested for 10 years. The key is Susan's decision to start investing early. She invested ten years earlier than Bill and required less capital. The remaining work to produce this incredible outcome for her was completed by compound interest.
The third person - Chris is the ideal situation. He began investing young (at 25) and continued for 40 years. As a result, he increased his initial investment of $200,000 to $1,142,811 at an assumed annual return rate of 7%.
2. Benefit of an early start
This chart not only shows the power of compound interest but also emphasizes why you should start as early as possible.
Assuming a 6% annual return, Emily and Dave in this example each contribute $200 per month to their savings. The only distinction is that Emily begins at age 25, which is ten years earlier than Dave. By the time they reach 65, Emily will have contributed $96,000 and Dave $72,000. Even though Emily contributes 33% more to her savings account than Dave does, at age 65, Emily's account has doubled Dave's in size thanks to the compound interest. Dave currently has $203,118, while Emily has $402,492.
Source: Business Insider
3. Becoming a (US$) millionaire is at your sight
While it may sound like a joke or require a life-changing investment opportunity to turn a small amount into a fortune, the truth is that the power of the compound effect can work wonders even with just consistent savings. In fact, the simple act of saving consistently can have a significant impact on your financial future.
Assuming a 6% annual return rate, consider the following chart which illustrates the amount of money you would need to save each month to reach the goal of $1 million by the age of 65, based on different starting ages.
If you begin saving at age 20, you would only need to save $361.04 each month. However, if you wait until age 60 to start saving, you would need to save a staggering $14,261.49 monthly to reach the same goal. Clearly, starting early and saving consistently is the easier path to becoming a millionaire.
Source: Business Insider
Any other types of compound effect?
Not only for financing but compound effect can be applied in all other aspects of your life. It can be in your learning, your expertise in any fields or nurturing your relationship. The example of Michael Jordan can give you some ideas on it.
Michael Jordan, one of the greatest basketball players of all time, utilized the compound effect to achieve his championship success. In addition to his natural talent, he consistently worked to improve his skills by practicing for hours every day and seizing every opportunity to learn and master his craft.
Using the compound effect formula, let's examine how he did it:
Compound Effect = Choices + Behavior + Habits + Time
Jordan made smart choices when he chose to prioritize relentless practice and a healthy diet to sharpen his basketball skills. He exhibited the right behaviors by being disciplined about his eating habits and ensuring he got enough rest.
Through consistent application of these choices and behaviors over a long period of time, he developed good habits that became ingrained in his daily routine. Over time, his consistent practice and dedication led to significant improvements in his basketball skills, ultimately cementing his legacy as one of the greatest players in history.
A Strategy for Growth: How to Leverage the Compound Effect
To make the compound effect work, we need to make the right choices, show the right behavior, cultivate the best habits, and allow time to take its course.
People are aware of the compound effect, but rarely consider the power of iteration over a long enough period of time to accumulate assets, expertise, and skills.
In this newsletter, I’m guiding you a simple way to achieve it.
Identify your "why": Every meaningful thing in life always starts with a “why”. Find your purposes as the long-term vision.
Set clear goals: Create specific, measurable, achievable, relevant, and time-bound (S.M.A.R.T) goals that align with your "why". Break down your goals into smaller, actionable steps.
Establish a system: Develop habits and routines that support your goals by identifying the daily actions you need to take to achieve your goals, and make them a part of your regular routine.
Start small and start early: Never think that you have too little capital, knowledge, or expertise to invest, start your own business, or pursue any worthwhile endeavor. James Clear, in his book "Atomic Habits," explained the 1% principle, which demonstrates the power of making small, consistent improvements over time. It's never too late to start doing something positive for your long-term growth and development.
Focus on consistency: Consistently work towards your goals by taking small, deliberate actions on a regular basis. Even if you can only dedicate a few minutes a day, the key is to make progress every day.
Here are some tips with my example that you can take to help build consistency in your efforts:
Develop a routine: To support my personal growth, I've established a daily routine that prioritizes learning. I've incorporated several activities into my schedule that I work on consistently, including:
Listening to audiobooks and podcasts: I have 30 minutes in the morning and 30 minutes in the evening for this activity, using my travel time to and from the office.
E-learning: I set aside 30 minutes at lunchtime every week day to learn a new skill or topic.
Reading and research: I spend 2 hours at evening every day reading books, newsletters, market updates, and studying stock charts.
While I remain flexible in reallocating time depending on my work schedule, this framework has helped me stay on track with my learning goals.
Break down your goals into smaller tasks: Breaking down larger goals into smaller, more manageable tasks can help you make consistent progress and build momentum. For example, For example, to publish this weekly newsletter, I break it down into smaller tasks like outlining key parts, researching, and writing each part everyday. After a week, I repeat this cycle again to prepare for the next one.
Prioritize your time: To develop my learning habit, I put the above schedule as my personal priority. If I receive an appointment that conflicts with this schedule, I evaluate its importance. If I accept the appointment, I will either adjust or shorten my learning schedule accordingly, while still maintaining its principle. This helps me avoid distractions that don't align with my priorities.
Hold yourself accountable: I commit with myself for maintaining this routine and conduct self-reflection monthly. If for any reasons I miss a day, I reflect on why it happened and make a plan to resume the routine in the following day.
Stay motivated: Staying motivated is crucial for achieving long-term goals. Since it's easy to become discouraged by the lack of immediate results, it's important to find ways to stay inspired and focused. For me, I find helpful to stay motivated by keeping connected to my "why" or purpose, reminding myself of the bigger picture and the result I will have later in my life.
Embrace the power of time: Understand that the compound effect takes time to show results. Be patient and persistent, and trust in the power of small, consistent actions to create big results over time.
For now, you may find the progress of compound effect overwhelming, especially if you're just starting out. Don't worry! The 1% principle is a great way to ease into a new habit with minimal effort. For example, if you want to start a reading habit, set a goal to read just one page per day. It is simple and achievable in less than five minutes a day. By doing this consistently, you'll create momentum that can help you to develop further.
Remember as long as you keep yourself on the race despite of distractions and discouragement, you are the champion of your personal growth journey!
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P.S: I will be taking a holiday next week, which means there will be no newsletter sent out. However, I will resume sending out the newsletter in next two weeks.
In the meantime, I will be sharing my daily learnings on my LinkedIn page. Let's stay connected and continue to learn together!
Cheers!
Do Thi Dieu Thuong