Understanding the power of compounding interest is key if you want to majorly impact any part of your life.
And the best part is that to have a massive impact on your life, you don’t need to make dramatic changes.
Actively taking small steps is the best way to make a change.
With the power of compounding interest, small changes bring about big results.
Compounding interest is most commonly talked about with regard to finance.
But you can profit from the power of compounding interest in all areas of your life.
All benefits in life come from compound interest, whether in money, relationships, love, health, activities, or habits
Naval Ravikant
So what is compound interest?
It is first and foremost a term used in finance.
In finance, compound interest is when the interest you have earned, is added to the principal amount. It is ‘interest earned on interest’.
Get wealthy with compounding interest
With compound interest, not only is the money you directly invested generating a return but also the return itself will accumulate and earn a return.
Therefore, your money can quickly grow from some small savings to a considerable amount through the power of compounding interest.
Of course, an important factor is that this effect relies on time.
You need time to accumulate interest and realise the gains from compound interest.
This is why the earlier you start the better.
In fact, as the graph below shows, starting to save just 10 years later at age 35 later, means ending up with 63,000 dollars less compared to someone who started at age 25.
Graph from Business Insider
In the graph, Red invested just 100 dollars a month for 40 years. With an annual compound return of 5%, Red ends up with 162,000 dollars.
Blue, on the other hand, invests the same amount of 100 dollars every month at a 5% annual return but with one difference.
Blue starts 10 years later at age 35 and ends up with 89,000 dollars.
That means Blue ends up with 63,000 dollars less than Red.
This difference in the final total is primarily because of the compounding interest that Blue missed out on, due to starting later.
This is just one example that shows how crucial time is in compounding interest.
However, if you, like many people did not already start figuring out how to earn, save, and invest money at age 25, then don’t despair.
As the saying goes “The best time to plant a tree was 20 years ago. The second best time is now“.
It is still better to start now, than wait even longer. And if you start now you still have an advantage over those who are even further behind.
Healthy habits also compound over time
Although the term compound interest comes from finance, we can use the concept in almost all aspects of our lives.
The power of compound interest in everyday life is realized through your daily habits.
The tricky thing about creating big changes through your habits is that most of the small changes will feel inconsequential at first.
It is only over time, that their true power in creating change becomes clear.
Take the example of brushing your teeth.
This is a twice-daily activity that seems tiny and childishly simple in the great scheme of things.
However, by repeating it twice a day, every day, for many years, you are improving your dental health considerably and avoiding costly dental procedures down the road.
The same applies to your physical fitness.
It might not seem like much at first to run just 1 km.
But if each time that you run, you increase your distance by 5% – which the first time you do it, is just 50 metres – you will be running 2.5 km by your 20th run.
The longer you continue, the larger this effect is.
Of course, compounding can also work against you.
Repeated negative habits also stack up over time and have a big effect.
A one-off break from your diet like eating a slice of birthday cake, won’t affect your overall weight loss goals.
But repeating that action and eating a slice of cake every night, will.
This is why it’s crucial to be aware of your daily habits and whether they bring you closer, or further away, from the person you want to be.
Build your relationship with yourself and others
The same principle can be applied to relationships.
The type of person you are is built up through your daily actions.
These daily actions or habits form the identity that you have with yourself and with others.
An example of this concept is your reputation.
If you consistently follow through when you say yes to an invitation or when you say you will do something, you are building a reputation as a reliable person.
This reputation is built and solidified with small everyday actions where you demonstrate your identity as being a reliable, trustworthy person, that others can depend on.
This has two important effects.
Firstly, you build a reputation with yourself as a “reliable” person.
Therefore, you begin to live this trait by proving its truth to yourself through your daily actions.
This has an iterative effect where you truly begin to embody this identity.
Secondly, you begin to build a reputation with others as this type of person.
And with each tiny action, you take that verifies this identity, you build your reputation as someone who can be depended on.
Naval Ravikant notes that:
“Compound interest also happens in your reputation. If you have a sterling reputation and you keep building it for decades upon decades, people will notice. Your reputation will literally end up being thousands or tens of thousands of times more valuable than somebody else who was very talented but is not keeping the compound interest in reputation going”.
You can apply this concept on a smaller scale with your personal relationships.
Think about who you want to be as a partner and what you want your relationships to look like.
Then work backwards from there.
If you want to have a healthy, happy relationship, then you need to be a good partner. What small recurrent activities can you do that will help you be a good partner?
Apply the idea of compounding interest to your daily habits and relationships and you will see how powerful this concept can be.
In summary; small, repeated actions, taken over a period of time can have a big impact on your life.
It is much too easy to underestimate the impact of small actions. But added up over time small actions have a massive effect.
Through the daily actions you take, you vote for the type of person you want to be and the life that you will have in the future.
Therefore, for once the advice is to look at the small stuff and see how it can change your life.
For more on the impact that small habit changes can have on your life and how to create change see the book ‘Atomic Habits‘ by James Clear.