Why Compounding Feels Like Nothing At First—Until It Explodes

“Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” —Albert Einstein

Perhaps you’re familiar with this quote. At the very least, I’m sure you’ve heard someone say how important it is to allow your money to compound.

Even as a child, I thought I understood this concept. If I’m earning 5% annual interest on a $5,000 investment, at the end of the first year, I’ll earn $250. If I don’t withdraw that $250, in year two I’ll earn 5% interest on both the original $5,000 and the $250 return. Year three builds upon everything earned in year two, and so on.

And there you have it, my friend—compounding, the eighth wonder.

It’s a simple concept, but I didn’t see the appeal. If anything, it was a letdown. After all, 5% of $250 is just $12.50. Big whoop.

So, letting that $250 compound earns me enough to buy two Starbucks coffees? I’d rather just spend the $250.

It wasn’t until I was much older that I truly got how powerful compounding is.

COMPOUNDING ON STEROIDS

I remember once walking down the street near Grandma’s house as a child with my dad. We passed by what once was a small sundry store. I had been inside a few times when I was very young.

It had long since permanently closed its doors, swallowed up by the passage of time. Green paint flaked off its dusty, wood-paneled exterior. Frayed holes in the window screens let you glimpse inside.

There used to be glass jars of unwrapped candies lining the shelves, a rack of comic books, and some random toys. The old Filipino man behind the counter was long gone.

“This reminds me of an interesting story,” my dad said. “There was this kid who asked for a job at a store. He told the shop owner that he’d only need to pay him just one penny for his first day on the job. Each day after, however, he would be owed double the amount from the previous day.”

My dad went on to explain, “So on day two, the boy would be owed two cents. That would turn into four cents on day three, eight cents on day four, and so on. The shop owner did some math and saw that he’d still owe the boy just $5.12 on the tenth day. It seemed a no-brainer, so he hired the boy.”

That made perfect business sense to me. “Then what happened?” I asked. “Well,” my dad said, “after 30 days, the boy was owed so much money that he ended up owning the store!”

I didn't see how this was possible. But there were no smartphones back then, so I couldn’t do the math right then and there. I eventually forgot about this story until I remembered it in my 30s. When I finally did the calculations, I was shocked.

After just 20 doubles, you’ll have $5,242.88. Double that 10 more times, and the amount balloons to more than $5 million!

It sounds unbelievable, but that is the power of compounding. In this case, the money is compounding at a rate of 100%.

The mistake the shop owner made was having a short-term mindset. He should have calculated past the 10-day mark.

“He who understands it, earns it…he who doesn’t…pays it.”

THE KEY TO UNLEASHING COMPOUNDING’S POWER

If you’re old enough, maybe you remember the Road Runner and Wile E. Coyote cartoons. In one episode, Wile E. Coyote rolls a pebble down a snow-covered mountain to form a small snowball.

It starts off rolling slowly but picks up more snow with each revolution. As the snowball grows, so does its ability to pick up more snow and speed. Soon, it’s an unstoppable, giant ball barreling down the mountain, continuing to grow.

Compounding is like this snowball. A tiny pebble can transform into a behemoth snowball, but only with time.

In the previous story, the boy’s wages doubled each day—a 100% daily return. There is no way to consistently grow your money that fast in the real world. You’d be lucky to find a savings account that offers even four percent annual interest in any given year. Index funds average a 12% rate of return. Real estate investments are about the same.

If you earn 12-15 percent a year, you would actually be doing pretty well. But it probably won’t feel like you’re doing well, especially in the beginning. When the amount of money invested is relatively small, a 15% return won’t look like much. And this can make things extremely frustrating.

Don’t let the initial small returns sway you into giving up entirely. Remember, in the story about the boy and the store owner, that boy was getting a 100% return. But even though his money doubled each day, he still only made $5.12 after 10 days.

Eventually, the dollar value of his returns quickly grew very large each day. But it only happened because he had the patience to allow the money to compound.

Warren Buffett, one of the world’s greatest investors, said this about the need for time and patience when investing:

“You can’t produce a baby in one month by getting nine women pregnant.” —Warren Buffett

YOU MIGHT BE LOOKING AT COMPOUNDING ALL WRONG

A long-term mindset is key to understanding the beauty of compounding. To illustrate, let’s take a look at visual examples of a short-term and long-term view.

Let’s see what a $1,000 investment earning 12% annually looks like if we don’t add any more capital.

I used to think compounded growth followed a linear path, i.e., a straight line sloping upwards at a fixed rate. And, in fact, the first several years of compounded growth does look like a straight line. This is because the dollar amount difference between each year’s return is small.

This chart shows what the first five years of 12% compounded growth looks like. After five years, the money hasn’t even doubled yet.

If I saw this, I’d think compounding was a waste of time. Luckily, compounded growth only look like this in the beginning.

In reality, compounding growth doesn’t rise in a straight line. Growth is exponential, not linear. It’s hard to notice in the beginning, but the line actually curves upward.

It just takes a long-term view to see this.

A 15-year view makes it easier to see that the line curves upward like a helium balloon in the wind.

Take an even longer-term view, and that compounded growth line really starts to look round. In fact, it’s beginning to go almost straight up. After 35 years, $1,000 would turn into over $47,000. And this is without adding any additional capital.

So, imagine what would happen if more money were invested each year. If $500 more were invested each year, after 21 years, you’d have $50,000. Of that total, $11,000 would be money you invested.

Continue to invest $500 a year, and at year 35, you would have over $262,000. Just $18,000 of that total would have come from you. The remaining $244,000 would be entirely compounded returns.

Now that’s something to get excited about.

Understanding and appreciating compounding growth requires a shift away from the short-term live for tomorrow mindset. It requires a long-term mindset that focuses on the distant future and plans for it.

After all, barring an unfortunate accident or illness, I’m sure you plan to live until you’re old and grey. Life is not a sprint. It’s a marathon that requires planning on how to complete the full 26.2 miles, not just one or two miles.

That's not to say short-term goals are bad. As part of a larger, long-term plan, short-term goals serve well as checkpoints. Use it to assess where you are and make any adjustments to stay on track towards your end goal. It's also good to celebrate the small wins along the way. Small rewards keep us motivated.

See you at the finish line!

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Disclaimer: I’m not a licensed financial professional. This blog shares my personal experiences and opinions around money, investing, and early retirement. It’s for informational and educational purposes only—not financial, legal, or tax advice. Always do your own research or consult with a qualified professional before making any financial decisions.