179. Staying on the path of Compounding
“Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things.” Charlie Munger
I had previously written on how beguiling the process of compounding is. More specifically, it does not feel like compounding really works in real time. A few forward steps tend to be followed by a number of backward ones. Progression and regression seem to dance in tow. After reading this past article, a good friend asked me how can we persevere on the path of compounding — particularly, given that it does not feel like it really works.
Here, in this article, I am going to share my experiences and reflections on this matter. I read a lot of biographies and also listen to a number of podcasts on this subject. So, what I share here also reflects what I learnt vicariously from the experiences of many contemporary and past accomplished folks.
“When it comes to compounding, don’t trust your intuition — you have no idea how powerful it is.” ― Manoj Arora
First of all, even if growth were to follow a perfect, theoretical compounding curve — smooth curve with small gains in the first several time-periods followed by big wind-fall gains in the last few time periods — many will still find it very difficult to persevere the many years of smallish gains and will most likely give up well before the windfall gains materialize. Compounding works by multiplying but our minds think in terms of addition.
People who invest in linear products such as Fixed Deposits or debt funds will enjoy near-benchmark returns throughout their investment tenure whereas investors in equity may suffer from long years of relative underperformance. In the slow growth phase of a compounding journey, it feels like you are failing behind compared to those around you. This is not a good feeling. We want to do well in the long run but, compulsively, in the short run too. For example, we do not like to let a vehicle pass us in a traffic jam even if the passing may release the traffic logjam.
“Delaying gratification is a process of scheduling the pain and pleasure of life in such a way as to enhance the pleasure by meeting and experiencing the pain first and getting it over with. It is the only decent way to live.” — M. Scott Peck
We do not like to sacrifice in the short run for the long run. This is probably because at the core of our personalities, we are animals. Unlike humans, animals do not have capability for “conscious” thinking (‘system 2 thinking’ per Kahneman and Tversky). Animal’s concern is to get through the day. Even when they do things for their future, it happens automatically, programmatically. I do not think a squirrel has a “conscious” sense to accumulate food for the cold months. It accumulates food by default. Ditto with ants and other living things. Animals are programmed to survive the present. The weight of evolution makes us also subconsciously prioritize our present. In fact, future is quite an abstract concept to us. By default, we struggle to imagine how our lives may look ten or twenty years from now. It is unnatural for humans to delay gratification. But compounding requires this quality and hence we struggle to capitalize the power of compounding.
All compounding entails is doing the right things, even if it is in relatively small magnitude, with consistency for a long period of time. It also requires keeping the faith that the journey will yield desirable results in due course.
How do you keep this faith?
“Good investing isn’t necessarily about earning the highest returns. It’s about earning pretty good returns that you can stick with for a long period of time. That’s when compounding runs wild.” Morgan Housel
The biggest secret to enable compounding is being consistent. Sustaining heroic efforts is difficult. So, plan on activities that you can persevere for a long period of time. They should not be so challenging that you will struggle at the first instance of adversity. Drastic weight loss regimens just don’t sustain.
By getting intimate with the nuts and bolts of the process of compounding. The journey of compounding is never going to be smooth. It will be messy. Only in hindsight does it seem somewhat smooth. Say, you are a computer programmer doing application development and doing well in your career. If you do not take time out to learn other, perhaps break-through, technologies, you may do well in the short run but your career will quite likely regress in the longer run. Whereas if you do set aside time for learning, it may seem like you are regressing in the short run but will quite likely do well in the long run. Companies that cut corners on R&D (research and development) or marketing and advertising activities, may save money and thereby show better results in the short run but may lose competitive positioning and correspondingly financial strength in the long run.
Only goals with deeply felt purposes have any chance of being met. If purpose is essentially extrinsic and the path to the goal is difficult, you may either lose motivation or get burnt out part way and hence abandon the goal. Staying on the path of compounding becomes easer if your goal resonates deeply within.
Bottomline
“The mantra is patience, patience and more patience. Think long-term and remember that the big rewards accrue with compound annual rates of return.” — Peter Cundill
Enjoying the journey goes a long way in keeping you on the path of compounding. Reduce obsession over a distant outcome and instead start liking the daily actions that go into making the distant outcome. Given our default propensity for instant gratification, it is better to ingrain the modalities of a compounding journey. Expect that your outcomes may not scale for a while. During the initial slow time-periods, you will continuously preserve and consolidate learning. As you learn, you become more knowledgeable. As you critically assess knowledge, you become wiser. As you become wiser, you will start pursuing activities with good long-term prospects and limit low value activities. You become more insightful. You become more patient and your capacity to suffer short-term pain soars. Even as your confidence waxes and wanes throughout the journey, you become prescient of your eventual success.
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Thanks for taking time to read this article. In this newsletter, I share my learnings that could help you improve your decisions and make meaningful progress on your goals. I try to share stuff that I have personally experienced or experimented with. If you find this newsletter worthwhile and if you do not mind it, please do consider sharing it with others.
I spend most of my time helping people make better decisions, build financial intuition and build great careers.
