Everyone has heard of compounding. Most associate it with compounding interest or money growing on money via long-term investing. Einstein once said those who understand compounding are rewarded by it. Those who don’t pay it.
In my experience, most know compounding intellectually but don’t believe it and certainly do not make long-term investing decisions on it. In fact, most make decisions that are “anti-compounding” or my term for not harnessing its power. Those who don’t like Einstein’s quote pay for this lack of knowledge by working longer and harder in life and not living the life they wish now or anytime in the future.
So, what is an “anti-compounding decision? It is one that has tremendous financial effects over time and is made without considering the financial consequences. This involves (yes, ugh) calculating numbers. Someone like Warren Buffet has been a master at understanding compounding and understanding its effect on long-term investing and wealth accumulation. He explained very simply recently in discussing his $300,000 haircut. Pay attention! This is probably you he is talking about.
Let’s say someone gets a haircut for $50. They get one every three weeks and spend $900 per year (14 X 50). If one did this or 30 to 40 years, depending on their rate of return and with the power of compounding, it could amount to $300,000 or more during that time. If the same person decided to spend $25 for the same haircut, obviously a cheaper haircutter, they might save $150,000 or more during the same period. All for thinking about what to pay for a haircut!
Yea, I know. You are 50 or 60 and do you really have 30 to 40 years left. Well Buffet just turned 90. You could have another 30 years to 40 years!
The whole point is compounding does a lot of heavy lifting in creating wealth via long-term investing. If one could add $150,000 of wealth by just looking for a cheaper haircut, image what wealth could be created by looking for a cheaper cable TV plan, giving up useless magazine subscriptions, skipping the daily lattes or something bigger like saving that raise or bonus! BTW saving $200 instead of $25 (or 8 times the haircut savings) with the same frequency, one might save over $1 million of wealth! This is the power of compounding.
I guarantee if you get the power of compounding, the next time you are getting a haircut, you might consider how much wealth you are giving up! Like Einstein said, those who understand compounding are rewarded. Those who don’t…..well their wealth takes a haircut!
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