Compounding effect : what is it and how can it help us increase our capital? We often wonder how to grow our savings so much to create a decent retirement or pay for our children’s college or simply have a more financially comfortable life.
The mistake that is often made here is to want to increase a lot of capital in a very short time. One is looking, in short, for the big break in life, the lucky break, like a lottery, an investment with very high risk but a mind-boggling return. Very often, however, the disappointment is enormous and sometimes accompanied by devastating economic losses.
Impatience often leads us to evaluate the results of our efforts from a short-term perspective. We want to have immediate feedback and do not realize that many things and situations need time to mature, develop and consolidate organically. This is not only in finance but also in life, in our projects and big goals.
Thus, there is a tendency to aim for “all and sundry,” forgetting that force that Einstein called the eighth wonder of the world.
The most important gains and changes are achieved with time and method: using precisely the strategy of the compound effect, in Italian compound interest. Named and praised by Einstein as the “eighth wonder.”
Yes because the compoundingeffect-or multiplier effect or compound interest-is that well-known principle in finance that allows one to increase one’s initial capital through the capitalization of interest.
How does it work then, the compounding effect ?
The workings of the compounding effect are simple, and like so many simple things we take them for granted and end up forgetting about them.
Suppose we save €1,000 each year for 10 years and put it in the bank. At the end of 10 years we will have 10,000 in our bank account. Considering the increase in the inflation rate (which will erode that value 10 years earlier because after 10 years with the same money I will be able to buy less), not having invested that money profitably in the end I will only have a devaluation of my savings.
Instead, what if I invest €1,000 each year getting 10% per year (from trading or investing in securities or etf)? How much do I end up with after 10 years? Some people will think I will come up with 11,000. And that is the 10,000€ set aside and the 10% interest earned each year for 10 years (100€ times 10).
Not so! You have not taken into account the eighth wonder of the world!
It is true that every year I earn 10% of my capital. So after the first year, having invested €1000 and gotten €100 in interest I will have €1100 in the account.
But the second year we will have 1100€+1000€, that is 2100€. So the first year’s savings plus its interest plus the second year’s savings. At the end of the year, with 10% interest on my new capital which will then be €210 I will find myself €2100 + €210, so €2310
In the third year, I will start with 2310€, add my usual 1000€ to it, and at the end of the year I will have 3310€ on which I will again calculate the 10% earning interest which is 331€. So after 3 years I will have 3641€ in the account.
To summarize: how much will I have in the account after 10 years, always saving 1000€ per year and earning 10% each year on the entire initial capital and putting the previous interest back into circulation? 17531€!
Well yes, in 10 years saving 1000€each year with the interest compounded at 10% per year we find ourselves almost doubling the capital. If you try this calculation on longer times or higher figures you will be astounded.
What happens without compounding effect?
Rob Garden, a British financial expert, calculated that setting aside for his own child 6 euro per day from birth to the age of ten (they make about 28.500 euros over a decade), upon retirement the former child turned 65-year-old would be left with a capital of 1,200,000 euros. This is if the capital saved plus the various annual interests remained reinvested in the market, which on average in the long run yields about 8 percent annually.
If instead of investing it in the market, Rob Garden put 6 euros a day under his mattress, to arrive at that amount in the absence of compound interest, how many years would he have to wait?
Five centuries. Yes: 500 years.
Also, in 65 years, how much would 6 euros per month be without investment and compound interest? 142,000 euros.
Retiring with 142,000 euros or 1,200,000 euros by setting aside 6 euros a day is the difference between someone who has never invested his daily savings of 6 euros and someone who has invested correctly and systematically in the market using the eighth wonder of the world: compound interest.
The strategy of multiplier through compounding effect in other areas of life
If we then want to put it bluntly and also praise this compunding effect, as Einstein did, we can surely see that the same mechanism of the multiplier or compound interest that we can use to accumulate money can also be found in many other aspects of life, which go beyond the financial sphere.
Mastering a foreign language, a musical instrument, or any skill; achieving any goal such as, for example, getting a sculpted physique or obtaining a degree, can be achieved by exploiting the so-called compounding effect.
The difference from money is that interest is earned through physical and/or mental commitment instead of financial commitment.
For example, let’s say you want to get a physique with muscles and well-sculpted. By taking advantage of the compounding effect you can achieve this over time and certainly not “all and soon.” Of course, success is contingent on the strict application of the strategy. The speed of achievement, on the other hand, depends on the initial capital, that is, your initial situation at the muscle level, and your ability to generate interest, which should be directly proportional to the commitment and constancy put into training.
On the first day of training you will have determined strength and endurance.
On the second day you will have taken a very small step forward that you don’t even notice, and on and on it goes.
After one year, the results will be obvious and almost exponential. Because it is true that every day you do the same exercise. But the muscles on the 30th day of exercise will be stronger and more resilient than on the first day. This is the compounding effect: the same exercise done with toned muscles makes them more toned faster.
This is also true in the study.
When you first start reading you struggle more. Even if you read 10 pages a day always, after a year, the 10 pages you read you will assimilate better and you will understand the meaning of what is written much sooner than the struggle you did in the early days.
So this eighth wonder can be exploited in many fields, although its application is not so simple. If we really want it to work, we must apply our method with patience, perseverance and determination. One must have the patience to wait for the results, not spending the interest earned along the way and continuing to invest with perseverance and determination!
Trading can be very helpful
Trading can be very helpful in finding resources to invest in the markets, even on a monthly basis, and you can certainly generate that 10 percent annually from your savings that no bank can give you. So too with investments in equities or etf.
The thing is not difficult but you have to know and well what you are doing.
That’s why we at OG Trading and Investment train a lot of trading trainees and investors on a daily basis. In just a few months we trained more than 500 people, and most of them began not only to earn money but to understand the value of patience, perseverance and applying a method well. This is a compounding effect that will lead to many of them having a much more peaceful economic future and achieving their dreams and goals.
And have you experimented with the compound interest strategy yet? In what area and with what results? What were the main difficulties you faced?