Compounding: Its not just for your portfolio

As I take a step back from my day to day profession for a few weeks and reinvent my personal operating model, I'm carving out time each day to read and write. To drive accountability, I'll regularly post a number of my thought pieces. If you have topics you think would be useful for me to explore, shoot me a note.

One of my favorite quotes comes from an ancient Chinese book of wisdom: “The best time to plant a tree was ten years ago. The second best time is today.”

On it’s face, it applies to taking action and simply getting started. But as with all good proverbs, there is another, less obvious insight I want to focus on: the power of compounding.

Nearly every professional understands the concept of compounding when it comes to managing your financial assets.  Simply put, it’s how you can go from $100 monthly contributions to a $1 million + portfolio in a few decades. Easy enough.

But the impact of compounding is nearly everywhere – and we often underestimate its impact in non-financial areas of life. Part of this is because we as humans default to linear modes of thinking. We don’t fully appreciate the power of non-linear, exponential growth. Another part is that we aren’t trained to see the effects of compounding, so miss it even when it’s right in front of us.

Compounding has an impact even when the seed growth rate seems relatively small. Between 1700 and the present day, the global population growth rate has been between about 1% and 2.1% per year. Even this modest range led to a 10-fold increase in global population within 300 years.

And despite the predictions of Malthusian enthusiasts, human flourishing rapidly increased over the same time frame. To greatly oversimplify, the 1700 population of 600 million had 600 “one in a million” individuals – the 2000 population of about 6 billion people had 6000 “one in a million” individuals. It’s no wonder we live in an age of wonders and opportunity never before experienced in human history (despite what daily headlines may say). 

What’s more, innovation and genius tends to build on past discoveries. And interactions between new ideas create even more points of opportunity. Remarkably, the compounding of properly empowered populations leads to further compounding as a result of increased interaction.

Zooming to the more micro, one need only look at something as simple as reading. A five year old who starts reading one page a day and continues the habit through high school will have churned through about 5000 pages by the time they graduate. Someone who averages half a page a day achieves 2500 pages. While this appears linear, the reality is more complex. Those additional 2500 pages are likely not equal to the first 2500 pages – they likely cover a broader set of topics and are likely of a more complex structure. Further doubling of the amount read to 2 pages a day introduces even more subjects and complex writing. The ability to draw connections and derive opportunities is likely far greater than 4 times the page count between the half-page a day reader and 2 page a day reader. Expand to the adult population median of 5 books read per year and accumulated knowledge diverges rapidly – the most voracious readers hit upwards of 80 per year. Executives in all professions tend to be voracious readers. Mere correlation perhaps, but linear increases in the habit of reading seem to create non-linear upside.

This concept extends to relationships and life skills. There are a number of lessons I learned at 35 that had I known about them at 20 would have been immensely useful…and would have given me 15 more years to implement their learnings. 

For instance, the lean startup model of deploy-learn-iterate is an incredibly useful mindset. I first formally came across it at Stanford while in my mid-30s. Previously, I usually waited for a near perfect solution before trying something. But today, I tend to push out a minimum viable product and iterate it based on market-like feedback. Decision cycles, and thus improvement cycles, are far more frequent, allowing a better long term product to be developed sooner.

I planted my lean-mindset tree at 32, but had I known and leveraged it at 20, the opportunities available to me may have been far different. It was a valuable mindset to uncover, and I’m grateful for being able to reference it for the past 6 years…but in an alternate world, I would have been on year 19 of a fast-paced decision and refinement cycle approach. The results would perhaps be similar to the Roth IRA I began at age 20 that has hit a surprisingly pleasing exponential inflection point.

One of the greatest unforeseen gifts I was given was the habit of consistently running when I was 15 years old. I’ve been getting out there 2-3 times a week for 25 years. While I have a sweet tooth with a love of really unhealthy food, the compounding effects of a strong cardio core will continue to pay dividends.

Compounding plays out in careers too – as an overly ambitious and arrogant 17 year old, I told my Mom I planned to be the Chairman of the Joint Chiefs of Staff, The Chairman of the Fed, and President. She rightfully rolled her eyes. At 38, I’m not anywhere near any of those things and at least two of the three are literally impossible to achieve at this point. Mostly because I haven’t accumulated the experience or knowledge that compounds over time to make such roles attainable. The compounding effects of the “right resume” tend to align with the pattern recognition frameworks present in hiring committee’s minds. This is something that can often only be achieved over time – and promotions tend to accelerate beyond a certain point. For instance, it can take 25 years to go from the first officer rank in the Navy, Ensign, to the sixth, a Captain. But one can leap from Captain to four star admiral (5 more ranks) in a matter of years. The “slow” apparent growth rate in the early years is actually a pre-requisite for the steep curve later on. Which mimics the trajectory of a compounded growth chart.

Compounding has negative impacts too. One poor meal a day over 20 years – say from age 20 to 40 – means you’ve accumulated that much more weight than you otherwise would have. Recovery may require a crash diet that causes further imbalance…or another 20 years of discipline to get back to a baseline. Add in an acclimated taste and less willingness to change, soon holes dug early in our lives can seem insurmountable as we age. Dig a hole deep enough, and even high recovery rates require a long time to match the baseline. If a stock loses 90% of it’s value, it’ll still take nearly a decade of 10% annual appreciation (far higher than the average historical S&P 500 historical return) to get back to where it once was.

So, what should we take away from this? 

Simply starting matters. The earlier the better.

The habits we develop and deploy matter.

And sometimes, plugging away and not giving up just prior to the exponential inflection point can make all the difference in the world. 

Compounding implies that a lot of hard work can seemingly go “unnoticed” only to explode to unforeseen heights. Overnight successes, do, in fact, typically take decades of preparation.