What is compound investing?

The Power of Compounding


Roughly 150 years ago on the Italian peninsula, a young mathematician with an interest in gardening, or maybe it was a young gardener with an interest in mathematics, noticed something peculiar about the pea pods he was harvesting from his pea plants. The pods were not distributed evenly over all of his plants. The majority of all of the pods came from a small number of high performing plants.

Even if you have never heard of the Italian economist, engineer, philosopher and mathematician Vilfredo Pareto, you have probably heard of his namesake principle. The Pareto Principle, commonly referred to as the 80/20 Rule, shows up in everything from pea pods to sales figures. For decades in many different industries, managers have noticed that, for example, about 80% of revenue comes from about 20% of customers.

That’s not the only place it shows up. If you have passed fifth grade you know that the Amazon Rainforest boasts an asotounding 40,000 different species of trees, it is the most biodiverse place on the planet. But as you may guess, only about 250 of the most common trees account for about 90% of all the plant life in the rainforest.

So what is it about those high performing species of trees that allow them to outcompete all of the other trees? Well trees need sunlight to hit their leaves in order for photosynthesis to happen and give them energy so they can grow. How much faster are these elite trees growing compared to the others? A hundred times faster? A thousand?

The few faster growing tree species that end up collecting about 90% of all the sunlight to hit the rainforest only need to grow one very tiny bit faster than all the rest in order to completely dominate them. The tree that can grow one tiny bit faster than its peers gets the advantage of being able to spread its one tiny leaf slightly above the others, and then is able to collect all of the sunlight it can, which in turn allows it to grow a little faster again.

If you haven’t noticed yet, this is the way the world works. The way to achieve vast success isn’t to blow away your competition. It’s much more mundane. The one who gets a tiny bit better every single day ends up reaping almost all of the rewards.

You can see this in all areas of your life. Gains are made a tiny bit at a time, but when done consistently, they can increase in frequency and add up to astoundingly high numbers.

Imagine a brand new insurance salesman just beginning his career. He has no clients and no prospects, but he decides to cold call one hundred people every day. After a week he still has not made a sale. But he keeps calling and after two weeks of rejection, he finally adds his first client.

So he continues calling, but since he’s been practicing and built up his confidence from that first sale, he only needs one additional week to make his second sale.

He keeps calling, but in addition to the cold calls, he asked for and got a couple of referrals from his first two clients, and it’s much easier to sell to those leads. So the fourth week he makes two sales from cold calling and one from his referrals.

Eventually his pipeline will be full of all warm referred leads and he won’t have to cold call at all. In addition, as he is building up his confidence making those sales, they are coming at a faster and faster pace. What’s even more, he is making it a point to ask for wealthier and wealthier referrals, where he used to ask for a referral to a client’s colleague, now he is asking for a referral to the client’s boss.

If he keeps that up for his whole career, you can see the spectacular success he will have. Sales are coming at an ever increasing pace, and for higher and higher commissions as well.

This is also the power of compound interest with your money. It starts off tiny, but your gains beget more gains, just like that insurance salesman. Start investing now. That money will grow a little but this year. Then save a little more next year and invest that with your original investment and the growth that accumulated.

You can do this in multiple areas of your life. The road to radical success is made by a series of tiny successes over and over again. When you work out, try to do one more push up today than you did yesterday. You don’t have to try to do fifty of them on the first day. Just do a couple, and keep getting better.

If you never improve, you will be the same person at the end of 2022 as you are now at the beginning. If you get one percent better every day, which is practically nothing, you can always get one percent better, by the end of this year you will be 37 times better than you are now.

Imagine being 37 times wealthier, fitter and happier that you are now. How good would that feel? Then next year, you can multiply that by another 37. That’s exactly what those few pea plants in Pareto’s garden did all those years ago.