ArticleThe Magic of Compounding

T2W Bot

Staff member
1,454 55
Have you ever wondered how Warren Buffet made his millions? In this article we look at the concept of compounding.
Some of you know about this, some of you don’t. Either way I’m going to give you the basics of compounding, plus a couple of new slants on the concept. I suggest you read The Magic of Compounding not just once, but several times. If you have children, print this write-up and give it to them to read. If they master this concept they will become rich.
The Basics
Compounding describes how numbers, or money, can grow. Numbers can grow in an arithmetic progression, for example 2,4,6,8,10,12 or 3,6,9,12,15,18, where one unit is added on at each step in the progression and that action provides the growth, or, numbers can grow exponentially, 2,4,8,16,32,64. In an exponential progression the increase comes by doubling the number at each step in the progression. See the difference? This is compounding.
Now the really amazing part, the magic, comes when you see how fast...

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timsk

Legendary member
7,087 1,880
Excellent article.
Simple points, clearly presented and I wholeheartedly agree with the author that these principles ought to be taught in all schools. I first read about the concepts way back in 1990 in an excellent little book called 'How to Increase your Personal Wealth' by Peter Cutler PhD. Utilising this simple idea enabled my wife and I to pay off our mortgage in double quick time. I suspect that many T2W members will regard the article as too simplistic and fail to see how they can implement the magic of compounding in their own personal finances. 10/10
Tim.

Junior member
34 3
Whenever I see an article about the gap between the rich and poor widening in this country, I think of compounding. If you go into debt, compounding works exponentially against you. If you save, compounding work exponentially for you. To me, the choice AND the result, is obvious. And there should be no doubt why the gap is widening.

However, it does make the national debt a very scary thing.

damianoakley

Established member
542 57
Whenever I see an article about the gap between the rich and poor widening in this country, I think of compounding. If you go into debt, compounding works exponentially against you. If you save, compounding work exponentially for you. To me, the choice AND the result, is obvious. And there should be no doubt why the gap is widening.

However, it does make the national debt a very scary thing.

That's an excellent point - banks work compounding in their favour on both sides of the fence. They lend money and they trade/invest money, both of which earn money for the bank.

Compounding is the foundation of wealth-building, but it can require a lot of patience!

Thanks

Damian

chump

Senior member
2,212 274
"Whenever I see an article about the gap between the rich and poor widening in this country, I think of compounding. If you go into debt, compounding works exponentially against you. If you save, compounding work exponentially for you. To me, the choice AND the result, is obvious. And there should be no doubt why the gap is widening."

Agreed, but there is a fly in the ointment. Compounding savings when the real net inflation rate is low/negative undermines the point you make that compounding works against you. In other words it does not always hold true.

If you just consider your personal finances to be a business it is obvious that lending and leaverage can work either for you ,or against you, depending upon the return you derive from the loan. In fact this is the global story of the last several years. As the 'wall of worry' from the crashes post 2000 kept a lot of people cautious those who who understood the point I made above grabbed as much cheap money as they could and put it to work. Meanwhile the compound savers got stuffed and indeed still are as the net real inflation rate means their savings are not working hard enough for them to move ahead.
By the time they realise this and unwind their caution the boat will have left the dock and be about to sink with most of the aforementioned opportunity onboard.