How the power of compounding applies not only to wealth, but influence, expertise, and creativity. How non-monetary investments can lead to greater monetary wealth and satisfaction.
In this episode you’ll learn:
- Why the rule of 72 and the power of compounding are hindered by portfolio losses.
- Why the sequence of returns impacts investment performance, but also our expectations.
- How what we experience in the world is made up of separate glimpses and events.
- What are non-monetary things that compound with time and why there are no short-cuts.
- How to focus our attention on things that compound.
- How non-monetary investments of our time can increase our monetary wealth.
We have all been taught to save our money so that it compounds over time as an investment for our future, but what if not just monetary wealth compounds? Is money a worthy investment of all of our time? How do our personal experiences influence our outlook on the future of our wealth—monetary and otherwise? In this episode of Money For the Rest of Us, David encourages listeners to invest not only with their money but with their time and creativity as well.
Be wary of simplified compounding schemes—it takes time for money to compound
“Save early. Save often.” While that may be a useful key to future wealth, is it really that simple? The rule of 72 says that if you divide the number 72 by your annual rate of return, the answer is how long it will take for your money to double. David unpacks this and other media-endorsed, simplified rules of compounding. Yes, your money should grow over time by means of compounding interest, but most schemes assume rates of return and annual savings at higher rates than most have or practice. The power of compounding only works if the individual doesn’t lose money in the process. If he or she does lose money, then it takes an exuberant amount to climb back up to even. For instance, if you have $100,00 invested in the market, and you lose 50%, then it will require you to gain 100% of it back again. Depending on how or if you have diversified your portfolio, getting back to even could take years.
The sequence of returns also matters in how your compounding scheme works out. If you invest $100,000, the end result will be drastically different based on if you saw an initial rise of 100% followed by a fall of 50% vs. an initial fall of 99%, followed by a 50% rise. We can’t choose the sequence. We don’t know what will happen. But the future is certainly influenced by what passes through time in the present.
Life experiences color our perception of what will come next
We remember what we have seen, heard, and experienced. Our perception of the world— and money—is influenced by our memories of the past. What we expect to happen is guided by what we have previously experienced. Just as the sequence of events matters in the market, it matters in our lives as well. David shares his experience as a money manager, walking through the Asian emerging markets crisis and then through the internet bubble in the early 2000s. His outlook on the future of investing was influenced by the sequence of those events. Who can say what his outlook would have been had the events of his career been mixed up? We are changed by our experiences, but we can never know what our future experiences will be. We only have the option to live life—through life and time as we garner experiences.
Not just wealth compounds—influence, expertise, and polish can also be compounded
The British artist David Hockney saw painting as a way to converse with and experience time—even after the moment depicted had fled. The time that the artist put into the painting could be seen and felt by those viewing it. It did not just depict one moment—but several. He despised photography because he saw it as a cheap way to freeze a moment in time. There was no passage through time—simply the frozen memory of a single instant. Hockney later went on to create a piece of artwork made out of hundreds of photographs, having found a way to create living art through many frozen moments. Not just monetary wealth compounds. Some things in life simply need time to mature—to become alive and influential. One’s influence, for instance, is not built upon a purchase—even though some try to buy themselves fame. It is created slowly, by wading through time and life. It compounds and becomes more full and rich with time.
Expertise or polish in a certain skill is also compounded through the passage of time. Wisdom and judgment are formed as we grow in our knowledge of the world and our skills in practiced areas of life. As we learn new things, our mental, physical, and emotional capacity grow as we inventory new ways of seeing and creating. Taking the time to polish or perfect a skill or an art form takes time. It takes a willingness to change and make better. David uses the example of publishing. It takes time to write a book, revise it, and publish it. You can’t rush passage through time. There are no shortcuts. Only the path through.
Learning to invest time in our creative side will lead to a different kind of wealth
David encourages listeners to invest in activities, things, skills, and knowledge that will compound over time. Yes, we should invest our money with the hopes that it will compound, but there are many other ways in which we can invest our time, energy, and faculties to make us better people—individuals whose wisdom, expertise, and influence will compound as we walk through time. Age will come, of course, but that is not something to avoid. A certain type of liberation and freedom is found when we invest ourselves in compounding interests, passions, and skills. We change, certainly. Time changes things. It strengthens our character—if we use it wisely.
- [0:20] The dangers of oversimplified compounding schemes.
- [4:30] Our experiences influence what we expect to happen.
- [7:57] A picture made up of pictures taken through time.
- [11:26] There are no shortcuts to forming experience.
- [15:05] Influence is created by passing through time—not by purchasing it.
- [18:32] Expertise, polish, perfection are all built by passing through time.
- [19:41] Taking the time to invest in creative work through time.
- [22:01] Time brings age—and that is okay.
- [23:11] Passing through time brings wisdom and experience.
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