Most Australians don’t understand compound growth/interest and it’s one of the biggest failings of our education system.
Albert Einstein, one of the world’s most famous physicists and mathematicians, once described compound interest as the Eighth Wonder of the World, saying ‘he who understands it, earns it … he who doesn’t, pays it’.
Warren Buffet, universally regarded as the most successful modern-day investor, concurs: ‘My wealth has come from a combination of living in America, some lucky genes and compound interest,’ he explained along his journey of amassing a net worth in excess of $135 billion.
Most Australians find themselves on the wrong side of compound interest.
The best way I know to describe the difference between simple growth and compound growth is by example.
Let’s say I take 30 steps. If I took simple interest steps, my 30 steps of a metre a step I’d have walked a distance of 30 metres.
If I took compound interest steps, my 30 steps would get bigger each time. The first step is 1m, the second step 2m, the third step 4m, and so on.
So, how far do I travel with my 30 compounding steps? I travel 13 times around the world. Yes, that’s correct, I travel a whopping 536,870,912m.
It seems unrealistic, impossible even, but there are examples of compound growth everywhere around us.
Apple, one of the world’s biggest and most valuable companies, sold its first iPhone in 2007. In 2009 it sold 5.41 million iPhones. In 2023, it sold 235 million iPhones. That’s compound growth in action, right there.
Buffett’s company, Berkshire Hathaway went from having $185 million worth of assets in 1980 to have $962 billion in assets in 2024. In 1980, you could buy a single share in his company for $290. The same share is worth $667,500 today.
Compound growth is like rolling a ball of snow down a long snow-covered hill. The longer the snowball goes, the more snow it accumulates and the bigger it gets.
Almost every success story is a story of compound growth.
The same basic principle must be the central focus when it comes to our financial habits.
Invest in assets that grow in value, hold those assets for as long as possible, and then reinvest the growth (or profits) in more assets that too will grow in value.
Perhaps no better example of our struggle to understand and practice compound growth is this.
In the year 2000 the Australian median house price was $200,000. Today, the median house price $850,000.
In 2000, there were 1,160,000 Australians who owned an investment property that is now worth 4 times more than what they bought it for.
Despite this, only 57,000 of the 1,160,000 (i.e. 1 out of every 20) have managed to turn their one property into a portfolio of four or more properties.
I wrote about it a few weeks ago, in my blog ‘the data behind the data’.
Almost everyone has heard of it, yet very few do it. Instead, they find themselves on the other side of compounding interest.
How else do banks, credit card companies and buy now/pay later providers become some of the biggest companies in the world?
Compound growth is not an easy concept to grasp. I don’t think I fully understood the power of compound growth until some six years into my Bulletproof Investing journey (I owned four investment properties at the time).
Before that point, I was following the advice of someone who had done it, trusting that his advice would push me in the right direction.
So, let me ask you this; are you doing everything you can to be on the right side of compound growth?
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