#006: Compounding – The 8th Wonder of the World

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

According to some, this quote is from renowned physicist and genius, Albert Einstein.
Whether he is the origin of the quote is irrelevant. Compounding is truly a magical force for wealth creation. And you must understand why many consider compounding to be the 8th wonder of the world.
To illustrate compounding, let’s use a simple example. You have $1000, and you earn 5% interest on it.

In Year 1, the math is straightforward. You earn 5% on your $1,000 which equals $50. At the end of Year 1, you have $1,050.
But what about Year 2?

Compounding means that you earn interest not just on your original investment, but on any interest or dividends that investment generates over time. The longer your investment remains untouched, the more it can earn in interest, and the more your wealth can grow.
Why does this matter? Because this means your wealth goes from experiencing linear growth into exponential growth.

The $2.50 in Year 2 might not seem like much. But over long periods of time, the exponential growth becomes massive.
As a real example, take a look at Warren Buffett’s net worth over time:

Compounding is what makes investments grow exponentially. Exponential growth is very difficult for our brains to understand, so trust the process, and let compounding do it’s magic. Although the concept is hard to grasp, you can learn by studying the world’s greatest investors.

Here’s how to leverage compounding:

• Start investing early. Even small amounts of money invested over a long period of time can build wealth.
• Invest for the long term. Avoid day trading, or trying to time the market. Buy and hold.
• Reinvest. Either dividends from your investments, or continually add to your portfolio over time.

Remember that compounding returns work in reverse too. If you take money out of your investment accounts, you not only lose the original amount you withdrew, but you also lose any potential compounding returns that money could have earned over time. This is also why high interest debt should be avoided at all costs.

To your prosperity,
Wealth Potion