On Compounding

Or what people miss when talking about compounding in life

In finance, the key to growing wealth exponentially over time is compound interest. Wealth simply grows faster when you earn a return on your capital, and then re-invest the return, to earn a return on that.

Many people have of course made analogies, applying the concept of compounding generally to life and work.

All the returns in life, whether in wealth, relationships, or knowledge, come from compound interest

Naval Ravikant

But what no one really talks about, is the concept of booking profits and cutting losses.

When it comes to compounding wealth, compounded returns are earned when there are returns in the first place to make compounding possible. Unless you invest in less-risky, fixed-income securities – on which you earn (compound) interest no matter what – chances are that there are going to be periods where you make little to no returns, or even losses. Or, if you do invest in said low-risk investments, it’s going to take a lot more time for your wealth to grow.

The key to compounding wealth (without taking time) then becomes:

  1. Taking just a little bit more risk, for more returns. But more importantly..
  2. Consistently booking whatever profits you already have, or cutting your losses early before they destroy your capital further.

You take out money from your existing investments that are not working out, and re-invest them elsewhere, where you think you might make more returns than before.

So how does this apply generally to life? On one hand, it’s of course about taking slightly more risks, and not being complacent. Maybe quit that stable job and start the venture you always wanted to. Or travel more, and meet more like-minded people.

On the other, it’s simply a matter of having frequent check-ins with yourself to see how you’re doing. If you feel that you’re missing out on growth opportunities, it’s time to book profits (or cut losses) and re-invest yourself. Once you start doing that, the possibilities are endless.