Einstein is reputed to have said: “Compound interest is the eighth wonder of the world.”
The great scientist was giving a nod to the remarkable compounding effect of small, regular actions when sustained over a long period. The power of compounding is not just limited to finance, we can see it all around us from the growth of forests to how we learn.
Yet the compounding principle is counter-intuitive. It jars with our linear thinking brains and our bias to the short term. We can calculate 9+9+9+9+9+9+9+9+9 easily in our heads as 81, yet the exponential 9x9x9x9x9x9x9x9x9 is beyond most of us, (it is 387,420,489 by the way). The effect of exponential growth catches us by surprise.
In the fast-paced world of entrepreneurship we can forget the compounding effect, with an emphasis on pace, first-mover advantage, the pivot. In contrast compounding rewards those who have patience, long-term thinking and consistency. Those who start early and stick to it are the winners in the compounding game.
Warren Buffett, the investor, who has built his fortune on the power of compounding, cites many examples. For example, he pointed out that if in 1540, Francis I, the King of France had instead invested the 4,000 crowns he paid for The Mona Lisa, the investment would have grown to a $1quadrillion and 3,000 times the French national debt by 1963.
The Norwegian Government made its first deposit in its Oil Fund (or Government Pension Fund Global) in 1996. Due to compounding and continued investment it has trebled in size in the last 10 years and is now worth $1,356 billion today – these funds are dedicated to the current and future generations of Norwegian citizens. An incredible legacy.
In Scotland, we can resign ourselves or get angry about the missed opportunity. Professor Mark Blyth, the Scottish economist at Brown University, and Eric Lonergan argue there is no time like the present. Low interest rates open up a real opportunity to build a Community Wealth Fund right now for Scotland.
Amidst the mind boggling £billions of the Norwegian Oil Fund and Buffett’s wealth, we can lose sight of how compounding is relevant to each of us right now. Think beyond the financial. Compounding works in education, networks, day-to-day business.
Our learning compounds over time provided we keep adding to it. Lifelong learning fuels a compounding effect. Our personal networks need development over a sustained period. Compare the person who blasts out connections to everyone over Linkedin to the person who nurtures their network building it steadily over time. Trust is the currency of networks and grows with a compounding effect.
The best entrepreneurs seek out sustainable compounding opportunities or growth loops. Whether it is the power of word of mouth or the famous Amazon flywheel. Similarly, social entrepreneurs like Steve McCreadie at the Lens or Kirsty Thomson at The Circle Academy produce compounding effects by promoting collaboration and fostering collective innovation for the greater good.
Time is the key variable in the compounding effect – the earlier you start the greater the impact. We may look with regret and anger at the Norwegian Oil Fund.
However, as an optimist, I am reminded of the Chinese proverb, “the best time to plant a tree is 20 years ago, the second-best time is now”.
The challenge to us all, our entrepreneurs, our policymakers: we must start now, be patient, consistent and think long-term. Whether it is for our businesses, climate, our society, the rewards may feel far off, yet exponential compounding can surprise us.
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