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Sahil Bloom

Sep 17, 2020 • 12 tweets • 3 min read • Read on X

Compounding 101

Albert Einstein famously said, "Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it."

But what is this great wonder and how does it work?

Here's Compounding 101!

👇👇👇

1/ First, some quick definitions.

Simple interest is interest that is paid only on the initial principal balance.

Compound interest is interest that is paid on the initial principal balance plus the accumulated interest from prior periods.

You earn interest on your interest!

2/ Let's use a simple story to illustrate the incredible power of compound interest.

Imagine you work for a tech company that was just acquired by Google. You cash out your stock options and receive a windfall of $1 million.

Your colleague Paul is in the same situation.

3/ You and Paul both decide depositing it in a bank is the safe move.

Simple Bank offers a high-yield savings account with 10% simple annual interest.

Compound Bank offers a high-yield savings account with 8% compound annual interest.

*Disclaimer: No, these rates are not real.

4/ Paul sees the 10% rate from Simple Bank and opens an account, depositing his $1 million.

You, on the other hand, have read the Einstein quote on compound interest, and decide to open an account at Compound Bank.

You're in this for the long-run.

So what happens next?

5/ Paul's 10% simple interest will earn him $100K every year (10% on $1m principal).

Your 8% compound interest will earn you $80K the 1st year (8% on $1m principal), $86K the 2nd year (8% on $1.08m), etc.

You earn more interest every year. Paul earns the same amount.

6/ After 1 year, Paul has $1.1 million and you have just $1.08 million. He gloats about his financial prowess.

"Just wait," you tell him confidently.

By year 7, you have leapfrogged Paul.

By year 20, he has $3 million to your $4.7.

By year 30, he has $4 million to your $10!

7/ "You should have listened to my guy Albert," you tell him over the phone from the library in your mansion.

The key here is that with compound interest, you receive the rate of return on both the principal and the accumulated interest.

It creates a snowball effect, of sorts.

8/ The same concept applies to stock markets, as the returns of this year compound upon the returns from last year.

Historically, putting money in a market index fund and allowing it to compound (reinvesting dividends) was the simplest, best way to build long-term wealth.

9/ I'm all for keeping things simple, except when it comes to interest.

Trust Einstein. Whether with savings, investments, or knowledge, let it compound!

@MorganHousel

10/ Following up on this thread, and inspired by @MorganHousel and his recent book (which is fantastic, by the way!), I'll be be sharing more stories of ordinary people who have built extraordinary wealth through simply harnessing the power of compounding. amzn.to/2ZNwgw6

https://twitter.com/SahilBloom/status/1284583099775324161

10/ So that was Compounding 101! I hope you found it useful.

And for more educational threads on money, finance, and economics, check out my meta-thread below!

https://twitter.com/SahilBloom/status/1284583099775324161

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More from @SahilBloom

Sahil Bloom

@SahilBloom

Apr 23

I can't stop thinking about this idea...

The 3 Types of Friends:

(everyone should read this)

The idea originates from Tyler Perry (portraying his wise Madea alter ego).

It's a brilliant framing for thinking about your relationships.

There are three types of people in your life:

1. Leaves
2. Branches
3. Roots

Here's what they look like...

LEAVES

These are the people that are only around from time to time when the weather is good.

They blow around as the winds change.

They provide shade during the summer, but as soon as winter comes, they fall off the tree and disappear.

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Sahil Bloom

@SahilBloom

Apr 20

The secret to success that no one tells you about...

Avoiding the Compound Mistake:

(thread)

Let's begin by referencing the image made famous by Atomic Habits.

While most of the dialogue focuses on the 1% better every day, which results in a ~38x improvement, the 1% worse every day is just as important:

It effectively zeroes you out—it knocks you out of the game...

When I was playing baseball at Stanford, the coaches had a metric they liked to track for pitchers called the Compound Mistake.

The idea was simple:

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Sahil Bloom

@SahilBloom

Apr 17

I challenged myself to cold plunge every morning for 100 straight days.

- Three different continents
- Several frozen rivers and lakes
- Dozens of hotel bathtubs
- One icy shower at 40,000 feet

10 lessons learned from 100 days in the cold:

(a video thread)

Lesson 1: Discipline is about what you do on the days when you feel like crap.

It's easy to be disciplined and consistent when you feel great.

It's hard when you feel like crap.

Those are the days when you remind yourself that you are a winner.

Lesson 2: Stop overthinking, just start.

"No plan survives first contact with the enemy."

Too many get their dopamine from the planning. Too few get their dopamine from the doing.

Plan a bit, then make first contact with "your enemy" and start improving fast.

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Sahil Bloom

@SahilBloom

Apr 16

This idea changed my life (and may change yours)...

The Law of Reversed Effort:

In a Zen parable that I love, a martial arts student approaches his teacher and asks, "How long will it take me to master this craft?"

The teacher replies, "10 years."

The student, looking impatient, responds, "I want to master it faster than that. I will work harder than anyone else. I will push myself to practice for many hours every single day. How long will it take then?"

The teacher considers this new information and answers, "20 years."

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Sahil Bloom

@SahilBloom

Apr 14

Advice from a mentor that changed my life:

There’s no such thing as a perfect moment. There are just moments—and you decide what you make of them.

Waiting for the “perfect moment” is just a convenient, socially-acceptable excuse to hide from the thing that scares you.

Trust me, I’ve lived it.

A good sign that you're on the right path:

A lot of moments will seem perfect in hindsight, when they felt terrifying at the time.

Imperfect moments made perfect through action.

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Sahil Bloom

@SahilBloom

Mar 3

My entire life changed because of a leap of faith.

There are a lot of people out there who feel stuck, but trust me, you don't have to stay that way.

If you want to take a leap, here's exactly how I'd do it:

The change you want to make in life scary because of two asymmetries:

1. Information Asymmetry: You know exactly what this path looks like, but very little about what the other path looks like.

2. Evidence Asymmetry: You have abundant evidence that you can make it on this path, but very little evidence that you can make it on the other path.

To break through the fear and take the leap:

Step 1: Gather Information

The first step is to solve the information asymmetry.

The questions you should be asking (and answering):

What does the new path look like? Visualize it in detail.

How reversible is a decision to take this new path?

Note: Most people underestimate the reversibility of a big decision. You assume that if you leave your consulting firm, you'll never be able to get another job in consulting. That is usually patently false. Most of these career decisions are reversible.

What case studies exist on successful (or unsuccessful) execution?

What perspectives can you learn from people with real, earned experience on the new path?

Are there any examples of people who have made a similar shift to what you are considering? What can you learn from them?

If you use a thoughtful process to gather information, you'll balance the information asymmetry and shorten the gap considerably.

Step 2: Create Evidence

The second step is to solve the evidence asymmetry.

While still on your current path, you need to create tangible proof that you can build a life on the other side.

What proof points can you generate of your ability to execute?

• Find one customer for your prospective new venture.
• Make $100 selling something on the internet.
• Generate a few client leads to your new coaching practice.

The tiny wins build momentum and help solve the evidence asymmetry.

Step 3: Confront the Fear

Gathering information and creating evidence should get you most of the way there.

But the fear still exists.

Here's how to address it:

1. Reframe the fear as a good thing: It means you care, it means this is something that matters.

2. Deconstruct the downside of action: What is the worst that could happen? How bad is it, really?

3. Deconstruct the upside of action: What is the best that could happen? How great is it?

4. Deconstruct the regret: How much would you regret inaction when you're 90-years-old? Could you live with that regret?

As Seneca famously wrote, "We suffer more in imagination than in reality."

These steps get the fear out of your imagination and force it into reality.

Your Player's Guide to the Leap of Faith

There's never going to be a perfect moment to make a dramatic change.

The leap of faith isn't for everyone, but if you follow this general process, you'll be well-positioned if you decide to jump.

1. Gather information
2. Create evidence
3. Confront the fear

I hope this helps a few people out there take that leap they've been too afraid to face.

A new life is on the other side...

The most important piece here:

Recognizing the fear as a byproduct of the information/evidence asymmetry.

It turns something abstract into a solvable problem.