Compounding

We think about the word "compounding" in a needlessly narrow sense. Typically, we consider it only in the context of investment compounding. As in: If I save X dollars a month and it compounds at Y percent, I will have [buttloads of] dollars in 30 years.

Today I want to think about compounding more metaphorically and in a broader context. It's a much more powerful concept than it at first appears.

One aspect of compounding that's always interested me is how, over time, it transforms tiny differences today into enormous future differences. If you can stay patient, that is. Sticking with a simple (and once again, "narrow") financial example for the moment, imagine two median income households in the USA, and consider what happens if one household chooses to save and invest a couple hundred bucks a month while the other saves nothing.

At first, there's next to no difference between these households, either economically or in quality of life. To the typical middle class household, $200 doesn't really feel like all that much money. It doesn't feel like it really matters all that much whether you save it or not. Which is of course why many households fail to choose to save.

However, it's also true that saving a couple hundred bucks a month on a median household lifestyle would involve giving up very little. Hilariously little. Cancelling cable TV and getting a lowish-end cellphone plan would do it. Skipping a few dinners out per month would do it. So would choosing to drive a modest paid-off car rather than driving an expensive debt-financed car. Note also: combining all these steps would produce savings well beyond a couple of hundred dollars per month, all for a trivial change in living standards.[1]

So, for the average American household, is saving a couple hundred bucks a month trivial, or not? Certainly in the short run it may seem so. But in the longer run, these two households--with their "trivial" differences in living standards--will begin to diverge economically. Even at modest compounding assumptions of 7% a year (a reasonable guess at future returns for an ultra-low fee broad market index fund), a savings of $200 dollars a month compounds to an astonishing quarter of a million dollars after 30 years. Quite frankly, it's hard to believe such "trivial" incremental savings can morph into sums like this over time, but it's all thanks to compounding.

And that's just the money side of things--this post isn't even supposed to be about money! The truth is, compounding works in far more ways, on far more levels, and with far more nuance. When you start thinking conceptually about compounding, you begin to see many life domains where things start out very small, yet gradually transform into tremendous results over time. Just like that two hundred bucks, except better.

An example. Let's go back to that household above that decided to practice the act of savings, even at a "trivial" level of $200 a month. Actually, it's not trivial in the least, as we'll soon see.

Adopting this practice (think of it as a kata) will "compound" that family's future ability to navigate a wide range of psychological challenges, like deferring gratification, understanding desire triggers, and other psychologically manipulative aspects of modern consumer society.

Further, the meta-skill of how to get better at saving money also compounds: A family that can find a couple of hundred bucks a month in savings today will get far better at saving over time, leading to substantially more future savings.[2] Note further that once you're in a position where you are regularly producing excess savings, you'll gradually compound your competence at intelligently investing that savings. So, a saver will get better at saving, while also improving at investing, while also managing his psychology better, and so on. Level on a level on a level compounding.

What at first glance appears to be a trivial financial baby step later gives rise to a whole range of powerful skills:

* The ability to get better at saving and investing
* The ability to manage yourself psychologically
* The ability to visualize a future and plan for it
* The ability to maintain discipline and install good habits
* The skill of building skills

Better still, all of these skills compound too. You'll get better over time at each as you practice them, and, fascinatingly, your improvement in each augments improvement in all the others. All of a sudden we're talking about a matrix of second- and even third-order compounding.

And to take it one more step further, someone learning how to better navigate her psychology will improve at identifying instances where her ego subverts her efforts to grow. You could easily argue that ego management and ego suppression are the ultimate cross-domain skills.

At this point, an insightful reader should be able to see all sorts of life domains where these wide-ranging skills play formidable, and compounding, roles. Forget about turning a $200 a month into a quarter million bucks--you're thinking way, way too small!

Pushback
There's a predictable--and cynical--response to these ideas, and it deals with the presumed long-term timeframes involved. The pushback (actually it's an excuse) sounds something like this:

Compounding over 20 or 30 years? Years??? I'm already [insert your age here], which means in twenty to thirty years I'll be [choose an age that sounds old]. It's too late!

Let's start with a screaming logic problem. Obviously, the idea of giving up on doing something because you could have started earlier is a particularly toxic form of defeatism. It's also circular. Everybody starts when and where they start. If your first thought is it's too late for me, you're essentially saying that nothing is ever worth doing because you haven't already started. That sure makes sense.

Further, even the central premise of this complaint is flawed: In nearly all the domains we've discussed above, the compounding of skills is so rapid that you don't have to wait 20 or 30 years to get big results.

To see what I mean, think about the central topic of this blog: cooking easy, healthy and laughably cheap meals. This is based on the above skills of a) managing yourself psychologically, and b) visualizing a future and planning for it. Miraculously, you only have to "compound" of a habit of cooking simple and low-cost meals at home for a few weeks to develop substantial competence in effortlessly putting healthy, low-cost meals on your table.

Another example: in his brilliant book How to Be an Imperfectionist, Stephen Guise shows us how a laughably minimal exercise habit of "one pushup" quickly compounds into a well-grooved, consistent fitness habit. Forget years of compounding--that process took more like twenty to thirty days. Psychologically speaking, 20-30 days is about how long it takes us to permanently install a brand new habit.

Even in financial domains, where we typically do think in longer compounding periods, the premise that things take too long is still flawed. The ability to save money, for example, is a skill that compounds very rapidly. The average Your Money Or Your Life reader who quietly and sincerely completes the book's nine steps will develop skills at saving money they never dreamed of in a matter of mere months.

Finally, skills like the ability to manage yourself psychologically and the ability to visualize and plan for the future are intrinsically valuable skills that compound rapidly and can be used in almost any life domain. In other words, they merit practice no matter what your age or life stage happens to be.

Everybody typically thinks about compounding in the limited, long-term financial sense: that of investments requiring multiple decades to grow. Don't let that be you!


Recommended Reading:
1) Anders Ericsson: Peak
2) Stephen Guise: How to Be an Imperfectionist
3) Josh Waitzkin: The Art of Learning
4) Karl Sunstrom: Breaking Out of Homeostasis


Footnotes:
[1] In one of the many intriguing ironies of modern life, "giving up" things like televised media and vehicular status competition actually makes you happier. Anyone who's tried it knows it's true; anyone who doubts it hasn't tried.

[2] Saving $200 a month on a median income represents an extremely low savings rate, less than 5%. [Math: Median income in the USA is currently $59,000, thus $200 a month or $2,400 a year divided by 59,000 = 4.07%.] If you are familiar with just a few concepts from Jacob Lund Fisker's book Early Retirement Extreme, you could easily juice this savings rate enormously.



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