Compounds CompoundsCompounds, II

Read Part I here.

Most of us do not have a lot to start with, but as we have seen, it doesn't take a lot to start compounding money. Any consistent effort is a positive number in and of itself. Time is the great leverage not many people know they have at their disposal. Or sometimes do, but quickly give up when results are marginal, without allowing time to properly compound into something greater.

The process is the same with musical instruments, art, or meditation; you do not have to dedicate large amounts of time to these practices. Doing it is enough. Five minutes daily is better than an irregular biweekly practice. Naval Ravikant, a philosopher and entrepreneur whom I greatly admire, defines wisdom as knowing the long-term consequences of your actions. You just have to do it, do it again, and keep doing it. This is one of the ways of capturing what we call luck. You create your gravitational force. Maintaining this consistency without keeping track, overthinking, and comparing is simple in principle, but not easily achieved. Those who manage, though, are greatly rewarded. You know what will happen if you keep sleeping eight hours a day. Or the outcome of reading books daily. I have applied this belief to myself. At some point during my teenage years, I decided that I wanted to become a painter, and I became one. By ruthless, uncompromising faith. More recently, I decided to change careers and successfully manifested it by setting aside moments during my free time to study. I created my own luck, disdainful of the barriers. It is all about converting steps into jogging and then lunging and ultimately flying—but it starts with minimal compounding steps in the right direction.

It is worth noting that personal improvements are not a race. Many, and most particularly those with obsessive personalities, give their all for a specific goal only to either burn out or find that they aren't necessarily happy after reaching that coveted checkpoint. The hard truth is that you will never be satisfied by chasing projections. A mountain climbed will become a seamount by the time you reach the top, and there will always be the next one to climb. Therefore, steadiness and balance are key; live today the life you want to live when you make it, there is no later. The quality of your life today will be the metric for your long-term happiness.

Our capability to adapt may be our greatest evolutionary asset, but it is also a shadowing enemy. You adapt to whatever your situation is, be it extremely poor or excessively rich. A 2000 gaming console is as fun as a 2023 one, the experience depends solely on the users’ acclimation. Reaching targets will not change you, they should instead be made integral to who you want to become. The pursuit of mirages makes slaves of us all.

Due to inflation, there is no stasis state, no interest awarded to your money equals paying it. Looking the other way will not attenuate its course. It is the same with any problem, leave it unchecked, and it will only grow bigger. Whether it is money complications, health issues, or social ones. A children's story, There's No Such Thing as a Dragon, by Jack Kent illustrates this beautifully. Billy wakes up to find a dragon in his room. He informs his mother, who declares that there is no such thing as a dragon. The dragon grows each time it is ignored until it fills the whole house with its size and runs away with it. It only deflates when he finally becomes acknowledged. The moral of this story is simple: we should be careful with the future—it lacks patience. If we don't advance towards it, it will come for us. Time only magnifies the sacrifices needed to correct what should have been faced from the beginning.

If you want to know your past life, look at your present condition. If you want to know your future life, look at your present actions. – Padmasambhava

Let us first take a look at what a span of a few years can do to the growth of money. A 20-year-old who decided to invest ￡200 a month until retirement at 60 (this is ￡96,000 in total contributions) with an average 10% yearly return (we will discuss this easy-to-achieve return figure in a later post), at retirement age, would have ￡1,168,444. Yes, above one million. This is a total profit of ￡1,072,444 over the initial sum. Conversely, if he had started at 30 with the same retirement date and identical yearly return, he would have had ￡434,264 at retirement. This is still a large sum, with a profit of ￡362,264. The difference between these two returns is only ￡24,000 in contribution, which leads to a drastic total return difference of ￡734,180 in favour of the 20-year-old. If he had started at 20, but only kept assets in cash, he would have accumulated ￡96,000 instead. When we take into account the average inflation of 2.5%, the purchasing power would decline to ￡35,753.

It is also possible to easily estimate when your money will double, though not with total accuracy, as past returns are not promises of future returns. By using the Rule of 72, a 10% annual return would double your money in 7.2 years. This is done by dividing 72 by the rate of return.

Monthly contributions would almost double the amount of time for returns to equal the deposited money, but they would grow at a much faster rate. The addition of ￡100 monthly contributions, for instance, would multiply the balance in year 8 by almost five times, to ￡5,267.

Gains acquired should be appreciated with a grain of salt. A 20% gain on a ￡100 principal would leave us with ￡120. However, a subsequent 20% decline would not leave us with ￡100, our initial sum, but with ￡96. The more you have, the more you will get, but also the more you are at risk of losing. It is important to accept that there will always be downturns. The market spends a lot of time in the red, and slightly more in the green, but this small difference makes for all its growth. Good things come for those who wait, and it is no different with investing, the impatient will always stand on the losing side. Often, investors wait for the market to go down to buy at low prices and, conversely, refrain from buying when it rises. This ignores the fact that historically there have been more upward movements than downward, it also includes emotions in the equation, which leads to mistakes and sleepless nights. By instead investing regularly, the risk is greatly reduced, and the investor is guaranteed to average a great entry price for the long term.

Every year delayed is an opportunity cost paid. The Time Value of Money is an important concept to understand if you wish to manage your money effectively. Your money is more valuable today than it will be in the future. This is the case because due to time, you are forsaking potential interest while incurring inflation nonetheless. However, this is no recommendation to borrow money to invest. While we can make good assumptions based on past data, the future remains uncertain. The past pandemic has been a good example of this.

By now, the importance of making your money work for itself should be obvious. But risk is another variable that will affect returns as much as time. A practice by individual investors and target-date funds is to decrease their risky allocations, such as stocks, based on the retirement date targets. A rule of thumb often used is to subtract your age from 110, and that will determine the amount of stock you should own. Based on Rule 110, at 30, your portfolio should be 80% in stocks; at 60, this diminishes to a 50% allocation in stocks. Nevertheless, this doesn't take into account our personal risk tolerance. Men, for example, tend to be less risk-averse, a reflection on our life span, but while some can still sleep soundly while their portfolio is down 30%, for others this can be a large source of unnecessary stress. It can be assumed that the older you are, the less money you will risk in investments. A common occurrence on financial literacy platforms is older people asking if it is too late to start investing. It is never too late; the price for the previous years has already been paid and is not retrievable, but today is the next best day to start caring for your money. This remains true at any age.

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