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Compounding Returns in Real Life

November 28, 2014

NB: This article got deleted and rewritten. Hopefully, it suffers not for quality.

Earlier this week we discussed compound returns in finance. Today, I want to extend this principle to ‘real life’, and how decisions we make can have compounding returns or compounding burdens. While the idea of ‘compounding’ isn’t seen in so mathematical or precise and relentless a way as finance, its still a useful way to view things.

Compounding Returns

Imagine you were learning the English language. You first learn the alphabet. Then a little about prefixes, then a little about suffixes. You are putting in lots of time, yet you aren’t getting much out of it. Words and sentences still make little sense. Its only after a certain amount of time that a child “gets it”, and meaning comes out of this framework. When meaning does finally come, the child is then able to frame his old knowledge through the new framework of meaning, earning ‘interest on interest.’ In this sense, the investment of time can give you compounding returns.

Now, some of you might be thinking that this contrasts with the law of diminishing returns, which basically states that we get less return for each additional investment. Well, it does… to a point. When learning about something we’re going to make the gains at the fastest rate at first. Learning to cook to survive is a massive gain compared to investing the same amount of time to know how to pair wine with a meal. However, in our world specialisation is rewarded. Value can increase exponentially once one becomes a master in a certain field, or ‘specialised’.

Another way to view this would be setting up a business. When you first start, all your investment into advertising, renovations etc. will only be ‘rewarded’ with a small number of customers. However (if done well – and here we see that it is not a strict mathematical relationships in real life), these investments continue to earn interest by over time attracting more customers. The renovations for a good décor in a restaurant might lure a customer to sample the menu, yet they may also yield a ‘return’ by being a causal reason for his returning (other than the good food).

Of course, not everything in life yields a return in a compounding manner. But the ideas of investment, ‘good things come to those who wait’ and reaping what one sows are not so foreign in our world. At the very least, ‘tis good to be reminded once in a while.

Compounding Burdens

As with compounding returns in life, compounding burdens are not a universal principle.. and arguably those that do exist are better framed in other terms. Regardless, it’s a useful concept.

Let me use a lengthy case study of one of my hiking trips as an example. It will teach us a great deal aside from compound interest as well.

I set out on a hiking trip to explore some tracks I’d nearly got lost in in the dark months back, yet without any real sense of planning. My first mistakes? I hadn’t planned out my trip accurately, because of this I had no lunch with me for a long trip (I didn’t expect one) , because I had no plan I hadn’t alerted others where I was walking (I did have my phone tough). Finally – and this was extremely hard to realise at the day’s start – but my left leg had been slightly injured after a curious incident after bowling the previous night [1].

These were mistakes, but what you’ll probably notice is that by themselves they mean nothing. No lunch? No problem if less than 4 hours! These mistakes pay no interest in and of themselves.

For a while I walked. Exploring and exploring as tracks upon tracks lay before me. I was really enjoying myself. Its amazing what joy you can take from but the lowest hill when you have not walked for ages, when you have been attuned to seeing nothing in a drab cityscape, and following a river / lake along was brilliant. It lay at the back of my mind that, yes, I regretted not bringing lunch, but otherwise I was fine. It was day, the sun was shining, I had hours to be home at the hour I had promised to cook dinner, and sights lay before me.

I suppose my 2nd mistake was not paying strong attention to where one of the tracks ventured down from the hills to a stream. It was a simple turn, yet I was distracted. Again, this meant nothing. Other routes existed, I had daylight. But note here how my lack of planning had compounded into not knowing my route perfectly.

My next ‘mistake’ was pressing hard on the journey out and not really leaving any more time for the return journey (10 min in a 6 hour balance isn’t much). I had been slightly tired from some fun the previous evening. I didn’t realise as I was walking out, but I walked about 10km out over hilly terrain in a little under 3 hours. Not a rapid pace, but not a stroll. At this point my mistake compounded a little, and aside from being tight for time, my left leg hurt. It was fine walking, but a jog strained it.

At this point, I was a little nervous about getting back, stress was beginning to tinge my thoughts. But I still want you to notice that nothing bad has happened.

My walk back goes fine till I’m unsure whether I’m on the track, unsure of the route. Instead of slowing retracing my steps and figuring out the route, I boldly decide to take a route ahead. Its clearly not the right route, and slow ‘bush bashing’ ensures. I’m falling behind schedule and lost. I decide to head down near the stream because I know that if I follow it for long enough I’ll come back to the track.

At this point, the mistakes have started to compound. I have a very sore left leg, I’m lost, I have a tight schedule, I’m hungry, and I’m starting to stress because I promised I’d be back by a certain hour. I’m a man of my word. I don’t break my promise under any circumstances. Still here though, nothing has happened, its just that the possibility of something bad happening has greatly increased.

Walking along the stream I see on the other side of the lake what I think is the track I came from earlier. I come to a narrow part of the stream. The water doesn’t look too deep, and there is a rock for purchase on the other side. Nervous as I am, I decided to ford the stream.

What a stupid mistake.

The stream was much deeper than I thought. Knee height became chest height, and if not for that rock for purchase I’d have had some trouble. Stupidly, I forgot to put my camera in my backpack. A watery grave for it. And my phone, inside my back-up, though I did not discover it till the next day, was also basically inoperable.

And the saddest thing? When I got to the other side and walked for 30 seconds I knew exactly where I was. Mere minutes from meeting up with the track. But… because of all those earlier mistakes, and with my mind in a very bad mindset, I didn’t step back and take a breath before fording the stream. It was “Panic! I’m late!” , not “Let’s evaluate my options” . Don’t panic.

In the vein of compound interest, my phone going dead nearly screwed over 1 social event of mine the following day, and completely killed a social event the following day, because it prevented the rectifying of a miscommunication / late arrival from others. Interest on interest.

Soaked and sore I walked back home. I arrived tired, hungry and exhausted.

The message here is simple. Mistakes compound, and your danger worsens with each step. Eg. Having a drink might weaken your senses. Driving while drunk is another mistake. Driving fast while drunk another. Yet its only the 3rd mistake that is truly likely to cause grave damage.

Conclusions

The funny thing is that I’m not so sad about my hike in hindsight. I regret fording the stream, yet it was an experience I’m like not to forget. It was an investment in experience and growth that brings returns, even if not compound returns.

Compounding returns are not universal in our world, but they’re certainly a useful heuristic. Be aware of them, that you may act wisely.

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