Compound interest goes in both directions

There is no shortage of writing and punditry about the power of compound interest.

As usual Naval has a pithy tweet about it:

I have been thinking about this a lot lately —  in the context of work, health, family, finances etc.  And more specifically, how compound interest is not just something that works for you, but it’s also something that can (and more than often, does, speaking globally) work against you.  I think of it like this:

Ways that compound interest can work for you:

  • You eat well and exercise every day – each month you are x% stronger and healthier
  • You’re able to save – each month you’re x% wealthier
  • You invest in friendships – each month they get x% stronger
  • You work hard, help your teammates, and contribute to your team’s success – each month you become x% more valuable
  • etc.

Ways that compound interest can work against you:

  • You get stuck in a debt spiral and every month are x% farther in the hole
  • You feel overwhelmed at work and each month get x% farther behind on your inbox and your projects
  • You ignore your friends and each month get x% more distant
  • You’re around bad people and bad things happen – you go to jail and meet more bad people, and more bad things happen
  • etc.

In other words, when things are good, they tend to get better.  And when things get bad, they tend to get worse.  This is a horrible paradox.  (Reminds me a bit of The Pursuit of Happyness which illustrated this beautifully and painfully).  I would argue that “health”, defined broadly, is about getting to the right side of the curve, where your efforts are not only making you net better, but they are contributing to potential exponential improvement thanks to compounding interest.  And getting away from the left side of the graph, where every day, every moment, has the potentially of compounding the badness.

Last week, I was talking about this with Darsh, focusing on the importance of helping people (ourselves and others) get to the right side of the curve.  Given the dynamics here, it is often a generational issue.  For example: my great grandfather was murdered in Russia for being a Jew.  That’s about as bad as things can get – getting murdered for being who you are.  My grandfather immigrated to the US, penniless, and died of cancer at a very young age.  My father grew up on welfare, in a difficult home, but managed to graduate high school, learn to program, and then ultimately start his own business.  I went to college (first one on that side to graduate) and now work at an amazing place in an amazing industry.  The climb from absolute terror, to extreme poverty and difficulty, to relative comfort has taken at least 4 generations.  And even so, I didn’t learn about the compounding nature of money and other wealth as a kid, and am just working on teaching it to my kids now.

A question, then, is how to short-circuit the cycle of negative compounding interest — getting at least “to zero”, so that the riptide is no longer pulling you under.  Because if you can’t do that, it’s very hard to start to benefit from positive compounding. It is for this reason that I am a fan of universal basic income and other systems that give people a boost.

One thought on that is, to work on positive compounding interest wherever you can — that might be work, health, savings, relationships or something else.  That’s why I am so excited about our investment in Stash – they are singularly focused on helping individuals achieve compounding financial interest through saving and investing – even just with $5.

With that, I will hit publish and hope for some initial returns on intellectual capital in the form of this blog post….

10 comments on “Compound interest goes in both directions”

That’s quite inspirational that your family was able to turn around in 4 generations. I think it also shows how privileged and lucky we are growing up in the United States.

I noticed that Stash isn’t FDIC insured but does seem to be SIPC insured. Would you say Stash is a better app, than say Robinhood, which is an app that all my friends like?

I’ve always thought that people too often focus on compounding their effort to get that positive convexity: work harder. I’ve always instead thought: “compound your luck. ”

Luck tends to be non-linear in nature, and when you have a positive jump, you want to sprint with it.

Comments are closed.