Compounding Value

Consider this page to be perpetually incomplete. Perhaps there is just an outline here waiting to be fleshed out. There’s always more to add, but it was lasted updated on: [8/7/2020]

In finance, many people understand how compound interest works, at least in the abstract. You put money (the principal) away, and it grows faster over time. Stated otherwise: the money doesn’t merely increment, it compounds.

But compound interest requires time to work. You can’t just put $1,000 into a savings account or an investment vehicle and expect it to be $100,000 the next day. You need to keep adding money to that account, and interest will keep compounding it over time.

However, compound interest doesn’t only work in our favor. Anyone who has held debt knows this.

Compound interest also increases the amount of money you owe on any loan, especially as the term of your loan gets longer. And, compared with savings and investment, it’s much easier for most people to stumble into an adversarial relationship with compound interest via credit cards, students loans, and other instruments of consumer debt.

The overall lesson here is that both good and bad, advantage and disadvantage, grow over time. And their growth rate is more than linear. You should keep feeding the good, and you should avoid or minimize the bad.

This is not only true with money, but with values throughout your life:

  1. Friendship – you can’t make old friends.
  2. Knowledge and skills – the more you know, the easier it is to see more and more connections within and across domains and learn faster.
  3. Your health – good health makes engaging in a healthy lifestyle easier, and bad health makes engaging in a healthy lifestyle harder.

I know plenty of people who realize the power of compound interest upon money, but then they turn around and say things like:

  • “Well, I’ve always wanted to do x. I’ll get around to it eventually, maybe when I retire.”
  • “I’ve always wanted to try that. I’ll get around to it sometime.”
  • “I want to live in x place. Maybe I’ll move there some day.”
  • “I’ll start eating better tomorrow.”
  • “I’ll start exercising next week.”

They don’t realize that they’re saying the equivalent of “I’ll start saving money some day. Maybe when I retire.”

You only have one life to live, and life operates on you and your values like interest operates on money.

(Of course I realize you can’t save all the time, and sometimes debt is needed. I didn’t want to stretch my metaphor too far, and the basic point of interest operating for good and ill at a faster-than-linear rate is what’s important. Also: unless you have an equity instrument, I know that savings and investments are actually just debt that you’re on the lending side of, so you’re the one that’s getting interest payments, but again, no need to get into that here.)