209. (Compounding Mini Series) 1. the topic that never gets old
“If you understand compound interest, you basically understand the universe.” — Robert Breault
I came across the concept of compounding when “compound interest” was introduced as a topic in high school mathematics. It remained just a concept and a formula in my mind for far too many years. Occasionally, I did come across anecdotes that extolled the power of compounding but those stories remained as things to be marveled at and occasionally recounted in suitable social settings (to show off my breadth of thinking). Only in the last few years have I started to understand compounding at a deeper, somewhat visceral, level. I have started to see its applicability and potential in pretty much every aspect of life (and nature). In a linear world, there is hardly any scope for impressive successes. The more the input, the more proportionately the output. Whereas, in anything that reflects fantastic or extraordinary growth or accomplishment, the concept of compounding seems to play a central role.
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” — Albert Einstein
Two striking examples of Compounding
Evolution
Evolution is perhaps the greatest example of the power of compounding. Life which started out as simple organisms is currently at a point of unfathomable range in terms of biological diversity and complexity.
Single celled amoebas had practically no physiological complexity. Over time, the cells split and copied themselves, occasionally imperfectly causing mutations. After about 3.7 billion years, we now witness organisms with hundreds of trillions of cells with enormous physiological complexity.
Warren Buffet
“My life has been a product of compound interest.” — Warren Buffett
Warren Buffet is one of the richest people in the world today. As of early 2025, at 94 years old, his net worth is about US$150 Billion, making him one of the richest persons on earth. At 56, he was not exactly young when he made his first billion. So, over 99% of his net worth was accumulated only after he turned 56. For more than half his life, he was not a billionaire. Paraphrasing his words (or were those Charlie Munger’s words, not sure), he accumulated above-average returns over a long period of time. Not spectacular returns, just above average!
There are many more striking examples in even more diverse areas but going into even a small number of them will be belabouring the point. In my mind, compounding is among the biggest wonders on earth. It truly creates wonderous outcomes.
The mathematical formula for Compounding formula is rather simple. Here it is.
Value = P * (1+r) ^ n
where…
P = principal value (benchmark value)
r = return rate (additive — variable)
n = number of compounding periods (exponent — variable)
In my experience, I have seen that “r” and “n” generally get the most attention. Most of us are engaged in the perennial pursuit of maximizing “r”. There is a magical allure to obtaining high returns. Many generally seek to take up actions that hold promise for significantly improving their lives.
There is enough literature out there (at least that I have come across) that urges one to increase “n” and not be too obsessed about “r”. Even though consistently doing the right actions for a long time, i.e., maximizing “n”, is hard, extracting high value from each action, i.e., maximizing “r”, is harder.
“Consistency and patience are crucial. Most investors are their own worst enemies. Endurance enables compounding.” — Seth Klarman
What about “P”? From what I have seen, the initial value (principal) does not get much attention. But “P” plays a very critical role in compounding too.
P, r and n — these are inert and boring when viewed as variables in an equation. But they take on vibrant, exhilarating and sometimes even eerie colours when understood in a wider context. They really come alive in their inter-play, when they feed into each other.
We will explore this vibrancy over the next few articles. Here is the high-level schedule (subject to change):
· “r” — the Hero Variable
· “n” the boring variable
· “P” — the ignored variable
· Key notes on Compounding
· So, what is the point, really?
Bottomline
“The elementary mathematics of compound interest is one of the most important models there is on earth.” — Charlie Munger
It feels like most success stories are essentially stories of the power of compounding. The mental model remains the same, only the details seem to vary. What is this thing about compounding that makes it so powerful? I was so taken in by the potential of “compounding mindset” that I wanted to understand exactly what goes into it, what comes in its way and how I can cultivate this mindset. The best way to explore and develop one’s own thinking is to write about it, of course. I have written about compounding in the past. I keep coming back to write on it sporadically. So, I decided to write a short series on my sedate exploration of this highly potent power. If you stay with this series, I think you will become more intimate with the concept of compounding and hopefully that will trigger your own exploration and cultivation.
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