Einstein called it the most powerful force in the universe. Buffett said it is the only thing you really need to know about investing. The ancient Romans respected this force so much that they actually passed laws to make it illegal.
In 1859, Thomas Austin became bored with the limited forms of recreation in Australia. He asked his friends in England to send him rabbits. Rabbits, he figured, could survive in Australia and would give him sport. Rabbits would give him something to shoot.
Estimates vary on the exact number of rabbits Thomas Austin received: some say twelve, others say as many as twenty-four. The exact number isn’t all that relevant. The important thing is Austin received his rabbits, a dozen maybe two. He dutifully released them into the wild. The rabbits proceeded to do what they do best. They made bunnies.
Some biologists call the spread of rabbits in Australia in the late 1800s the fastest mammalian expansion in all of recorded history. With no natural predators, plenty of food, and a knack for, well, creating bunnies, Austin’s rabbits wasted no time in giving Thomas Austin all the furry little creatures he could possibly hunt. The invasion proceeded slowly at first, then swiftly, then with the alacrity of Napoleon’s march on Europe. By 1940, there were no fewer than 600 million rabbits in Australia.
How did a couple dozen rabbits turn into 600 million? Oddly enough, it had very little to do with the original rabbits. If it were just the original rabbits having bunnies, the entire rabbit population even after 80 years would be something less than 2,000. No, the problem wasn’t with the original rabbits having bunnies; it was the original rabbits’ bunnies having bunnies and, even worse, with the original rabbits’ bunnies’ bunnies having bunnies. Each generation of bunny contained more bunnies than the one before it and all bunnies from every generation were having more baby bunnies.
The bunny population in Australia increased not linearly, but exponentially. Thomas Austin had introduced Australia to the power of compounding.
Continuous compounding working against you will crush you. Compounding as applied to interest on a loan is when unpaid interest is added to the principal and itself accrues interest. Like the rabbits’ bunnies’ bunnies having bunnies, compound interest working against you will quickly grow out of control. Slow and imperceptible at first. Overwhelming in the end. Compound interest is what the Romans abolished in ancient Rome. It was just too dangerous.
Continuous compounding working for you will make you rich. It is the secret sauce of Buffett’s wealth creation. He started young and let compounding work in his favor for a very long time. Slow and imperceptible at first. Overwhelming in the end. Buffett today has so many bunnies having bunnies that he completely loses track of all the zeros. The wealth Buffett creates on a single good day today is many orders of magnitude greater than the wealth he created from his initial investments. He used compounding to his advantage.
The most important thing here is to put yourself in a position to have the magic of continuous compounding work for you rather than against you. The longer the better. The way to begin – the only way to begin - is to spend less than you make and put the difference into some sensible long-term investments. Do it today.
