Compounding : 8th wonder of the world !!!

"Compounding is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." - Albert Einstein 

Compounding appears like magic but a little more awareness can help you get to the root of it. Compounding works like a snow ball falling down the hill. Initially amount of force and energy to create a snowball must be very high. However, as it rolls down the hill, snow ball will pick up more snow, gaining more mass and surface area and become very big snow ball till the time it reaches end of the hill.

Ask Warren Buffett for the single most powerful factor behind his investing success, and he’d respond “compound interest” — without skipping a beat. Compounding plays a major role for wealth creation in long run. The work you need to do in the beginning is often more. But once your wealth snowball is built, then your wealth naturally attracts more wealth. Compounding can create millionaires from average people. For using compounding as a tool, one does not require one to be a financial expert, but has to only ensure that funds are invested in asset which is growing steady in long-run.

Compounding is very powerful owing to the fact that return earned is converted to capital and again invested so total capital invested keeps increasing. As the total capital invested increases, so does the return for future periods. Equity as an asset class has provided the greatest return when calculated in terms of CAGR (Compound Annual Growth Rates) for longer periods of investment horizon. Equity may tend to be volatile and irregular in shorter horizon but in longer duration it is the best return generator for investors. No other asset class like real estate,fixed income instruments,commodities etc. have been able to meet returns generated by Equity. 

A Small Story on power of Compounding : 

There's a famous legend about the origin of chess that goes like this. 

When the inventor of the game showed it to the emperor of India, the emperor was so impressed by the new game, that he said to the man

"Name your reward!"

The man responded,

"Oh emperor, my wishes are simple. I only wish for this.
Give me one grain of rice for the first square of the chessboard, two grains for the next square, four for the next, eight for the next and so on for all 64 squares, with each square having double the number of grains as the square before."

The emperor agreed, amazed that the man had asked for such a small reward - or so he thought. After a week, his treasurer came back and informed him that the reward would add up to an astronomical sum, far greater than all the rice that could conceivably be produced in many many centuries !!!

Acting rationally, consistently, while harnessing the power of compound interest over a very long period of time is what has made Warren Buffett perhaps the most successful investor of all time. Why not harness it for yourself? Start early and think long term.

Thank you !! :)