The X Factor
Why you need to understand the power of exponential growth
A few months ago, I arrived at a venue to give a talk on financial wellbeing. I realised that my iPhone was almost out of power and I had left my charging lead at home. I asked the receptionist of the venue if she had a spare charging lead that I could use.
“Sorry we haven’t got a lead for your type of iPhone, and my own phone is an iPhone X so I can’t let you use mine.” She said. “You have an iPhone X? You must be doing well, they cost over £1,000!” I responded. “No, I do it on contract at £80 per month.” She replied.
The receptionist was about 20 years old and immaculately presented, and it appeared that she had used expensive beauty products on her face. But why had she decided that it was worth her spending £80 per month to have a phone that she didn’t need, given that a second-hand iPhone 6 would have cost less than £200 with no contract?
An expensive mobile phone and expensive beauty products are two obvious outward signs to others that this young lady is, ostensibly, doing well and may well reflect her unconscious need for acceptance and validation by others. But I wondered whether she is doing equally as well improving her overall financial wellbeing, particularly the ability to cope with a financial shock and build long-term wealth.
The reason I’m sharing this exchange is that it illustrates one of the single biggest challenges we all face when it comes to our financial wellbeing: that of balancing our desire for immediate gratification and material ‘benefits’, with the grind of earning an income, the tedium of saving and the boredom of investing.
It’s the amount of time your money is invested, with the earliest contributions making the most money, that matters most to building financial wealth (see my earlier blog How to Lower the Cost of Building Wealth). Compounding is the mathematical principle that something will grow exponentially if left to its own momentum. As Warren Buffett’s business partner Charlie Munger explained: “The first rule of compounding: Never interrupt it unnecessarily.”
But what few people appreciate is that the increase in the value of money accelerates as growth proceeds. A simple rule of thumb to help you understand this is the “Rule of 72”. This tells us how many years it will take for capital to double in value based on different rates of return.
For example, at 8% per annum it takes about 9 years to double. But the same amount of growth then takes only five years, then four years, then three years, then two years etc.. The fact is every large fortune started out very small.
In this short video I explain the concept of exponential growth.
The key message is save and invest as much as you can, as early as you can, with as much in a global equity index fund as your risk capacity will allow and leave it well alone for as long as you can.