Albert Einstein said compound interest is the eighth wonder of the world. While that observation pertained to the financial world, in this chapter we shall examine how the phenomenon of compounding is prevalent universally in all life situations and brings non-linear growth over a longer period of time.
If a business solves problems for the society it operates in with consistency over a long period of time, it develops into a dependable brand. This bond of trustworthiness between the service provider business and the customer brings into play the compounding effect when it starts attracting more work orders from the same customer. In business jargon, this is called a higher share of the wallet. This then spreads to new work from new customers, thus helping the business to scale up its operations. This is the secret formula for growth in all life situations, whether personal or professional. If you have delivered value to your stakeholders in the same organisation over a long period of time, you attract more responsibility and with that comes growth in your pay cheque.
Conversely, the inability to stay the course over the long-term acts as a natural filtration process, which is why we see a pyramid-like structure in organisational charts and in the world around us in general. To become a banyan tree, one has to be rooted in one place over a very long time.
Compounding effect explained
Though most people usually associate compounding with financial returns, a closer look will show it applies to various other aspects of life as well. In every such sphere, the process of compounding exponentially increases the rate of growth over longer periods of time.
Shorn of technical and mathematical jargon, the process of compounding harnesses the power of cumulative growth that builds upon the small incremental growth achieved every minute, every hour, and every day. Over longer periods of times, this cumulative growth adds up to a remarkably high rate of growth that is much higher than the incremental rate of return.
In life situations, the compounding effect is built on the foundation of trust which is earned and then sustained over a long period of time. When a business or a service provider solves problems for its customers consistently over an extended length of time, it builds a track record of delivering value, which helps it to earn the trust of not only its customers but also other stakeholders including its employees and partners. Satisfied customers then help attract new customers and this creates a virtuous circle of goodwill, higher profitability, and growth. This public trust, earned over many years, enables such a business to expand into new markets and extend its brand into related sectors. In this case, the trust earned by the business is the base investment and the reward that it earns in the form of expanded market share, larger top line and higher profits is the compounding effect. This is more than just the transactional nature of business. As word of its credibility spreads far and wide, it creates the foundation for the next phase of growth. That, in a nutshell, explains the power of compounding.
The secret formula mentioned in the introduction to this chapter is the ability to understand, harness, leverage, and exploit the exponential growth opportunities offered by compounding in one’s professional and business context. However, readers must bear in mind that one needs lots of patience and very strong nerves to benefit fully from the phenomenon of compounding. Very often, one encounters strong headwinds, severe turbulence, and temporary setbacks en route to one’s goals. Many people lose their nerve or run out of patience and abandon their quest for geometric progression. This acts as a natural barrier and filters out the potential winners from the others. Only those who can endure the trials and tribulations of a long journey can enjoy the fruits of reaching the destination. Hasty, impulsive, and knee-jerk reactions, therefore, have to be avoided in order to benefit from the power of compounding.
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Compounding in personal situations
Compounding works just as effectively in personal situations as it does in professional ones. We must always remember that it applies to every sphere of life. It is the lifeblood of enduring relationships built on the foundation of mutual trust. The element of trust, which is the lynchpin of the entire compounding process, can never be built overnight. It is the effect of long years of toil, loyalty, grit, integrity, and delivery. So, incorporating all these attributes into our lives is a necessary pre-condition to being able to harness the power of compounding in personal situations leading to wealth creation.
Let us first try and understand how compounding affects our day-to-day lives and how we encounter it in everyday situations. It affects every aspect of our lives—like the relationships that we build with family and friends over decades. While supportive families show unconditional support (unfortunately, not everyone is lucky enough to have this), close and true friends show up in situations of medical emergency, financial support, or even as a sounding board for taking critical life decisions like choosing a career, accepting a job offer, or even finalising a life or a business partner. Compounding is also evident where our health is concerned. An illness or medical problem when ignored could grow into such a large issue as to need surgery or long-term treatment. Conversely, if one takes care of all aspects of well-being: nutrition, physical, mental/ emotional health, they combine over many months and years to ensure a healthy life. Similarly, education does not stop after graduating from schools and colleges. It is a lifelong journey and the real education from the university of life only begins the day formal education comes to an end.
From these examples, it will be evident that small but consistent incremental efforts invested over a very long period of time is the root of all success stories. In every case, it will be clear that success is never the immediate result of one-time input. Rather, layers of the repeat inputs applied consistently over a period of many years are needed to produce a scholar academician, a champion sportsperson, or a maestro musician. That is how the power of compounding works. Internalising this knowledge can prepare us to face most life situations better and develop the endurance to stay in the game even when each individual step looks difficult, and the goal seems distant and out of reach.
Compounding in the professional context
The effects of compounding are equally apparent in the workplace too. Very often, we come across individuals and companies that have transformed their own lives and those of their stakeholders by delivering consistent value over extended periods of time. In the process, they have taken their own reputation and that of their employers to greater heights by leveraging the power of compounding.
Given below are some examples:
Professional skill development: When companies hire for new functions, they are looking for particular sets of skills. Individuals having the required skills stand a good chance of getting hired for such career openings. Some of these individuals have invested in themselves to acquire the skills required by employers after undergoing rigorous training despite having other pre-existing professional qualifications. Every new certification may not have brought any immediate rewards in their professional lives but over time, the cumulative effect of their incremental experience and qualifications bears fruit and they are able to climb up the professional ladder, with a bigger role and financial rewards.
There are enough examples of this in the world of sports as well. Sachin Tendulkar has said on record that he often spent as much as twelve hours a day on the field practising his craft and perfecting his game in preparation for when he turned out for India. This long-term commitment to excellence is what sets champions apart.
Similarly, commercial pilots have to log a minimum of 250 hours of flying time, of which 100 hours have to be in powered aircraft and 100 hours as pilot-in-command time. To become a captain of a commercial aircraft, one must log at least 1,500 flight hours and hold a full Air Transport Pilot’s License. However, most airlines promote pilots to captain only after they log at least 3,000 flight hours. IT professionals also add skills like artificial intelligence, machine learning, and big data analytics to their existing qualifications to stay relevant for the future. In each of these instances, people are adding layers of knowledge and skills to a pre-existing level of expertise to become even more valuable to the buyer of their services over a long period of time. This is the power of compounding.
This excerpt from Rohit Sarin’s ‘Unlocking Wealth: Secrets to Getting Rich at Any Age’ has been published with permission from Aleph Book Company.