The Compounding Effect

Bruce Lee once famously said, “I fear not the man who has practiced 10,000 kicks once.  But I fear the man who has practiced one kick 10,000 times”

The saying captures the essence of the compound effect.

The compound effect refers to how making small behavior changes can compound into life-changing results over time. It is about reaping huge rewards from a series of small, smart choices. The underlaying priciple of the compound effect is to reject the idea of quick fixes. Darren Hardy, who built this concept of Compound effect, based it on the Butterfly Effect. According to this concept, a butterfly flapping its wings on one side of the world can cause a mighty tornado in another part of the world.

Darren Hardy mentioned that the compound effect of habits is the combination of multiple attributes. These attributes help us understand our role better. The magic formula is: 

Small choices + consistency + time = significant results.

What the simple formula above means is that you

1) Break your bigger goals into smaller tasks that you can do every day.

2) Be consistent.

3)Persist and don’t rush. In time the results will be significant.

The one domain in life where the benefits of compound effect can be seen and measured is the world of finance. Compounding is crucial in finance, and the gains attributable to its effects are the motivation behind many investing strategies.  The interest income you earn may be calculated in two ways. It may earn simple interest, which means the interest is figured on your principal alone, or it may earn compound interest, which means the interest you earn on the investment also earns interest.

The way the interest is calculated will affect the yield, or what you earn on your investment. The more frequently the interest is compounded, the higher the yield, or the rate of return on your investment.

For example, if you had $5,000 in an account that paid 5% annually in simple interest for five years, you’d earn $250 a year, for a total of $1,250 in interest. In this case the interest rate and the yield are the same — 5% per year.

But the same $5,000 investment paying 5% interest compounded annually for five years would produce a total of $1,381.41 in interest. Because you’re earning interest on your interest, the yield — an average of 5.52% per year — is higher than the interest rate.

No matter your age or station in life, Hardy claims that if you make the decision to change your bad habits into good ones over time, you can accomplish your goals.

Those who understand the power of compounding  can make it work for them and those that don’t understand it spend much of life trying to get out from its shackles.

The neutrality of compounding is what makes it interesting If we can replace a negatively compounding habit that is positive, we get better. The earlier you start making those positive changes, the mkore the compound effect works in your favour.