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02 September 2014

The power of compounding in Life

This an article that I posted in LinkedIn Pulse. You can either read it here, or if you prefer, you can read it from the horse's mouth
I am currently in a self-created project of reading 50 books on Finance, Investment and Wealth creation and writing their reviews in my blog. So far I have covered twelve books.
You can read the reviews HERE
One of the biggest benefits of this exercise for me has been the knowledge and the value add that I am gaining. Since the field of Finance deals with money and money influences behaviour, a good book on Finance can add a lot of life lessons to your repertoire. Especially if they are based on the lessons learned by highly successful investors.
My LinkedIn post on 'Sitting Tight' was based on one such lesson that I had learned from the Book 'Reminiscences of a Stock Operator'
This post is about another lesson that I learned from a book that I just completedreview. It is about the power of compounding and the opportunity cost of inconsistency.
To set the tone, let us start off with some math on Investing.
Assume that you started off with three portfolios A, B and C investing 10000 in each. Your holding period for all the three portfolios is 30 years and they are expected to return 10% annually. Portfolio A gives you consistent 10% returns over your holding period, portfolio B gives you Zero returns in the years 10, 20 and 30. Portfolio C gives you negative 10% returns in years 10, 20 and 30.
At the end of 30 years, you would have;
About 171000 in Portfolio A
About 131000 in Portfolio B and
About 96000 in Portfolio C.
Even though your absolute loss is about 17000 in Portfolio C, the power of compounding has ensured that your holding period loss is about 76000. While each of the losses in Portfolio C were meagre, about 2000 in year 10 for example, the cumulative effect is humongous.
Lesson? Consistency pays. In finance.
And in life...
In my school and college days, my performance was inconsistent with a big I. I will perform exceptionally well in one year and exceptionally bad in another year. For example, till class 10, I was very poor academically and in Class 10, I did exceptionally well, then did very badly in Class 11 and performed exceptionally well in Class 12....
Each of those years when I performed poorly, were all non-evaluation years. The examinations were perfunctory. For example, Class 11 exams did not mean much, but Class 12 exams decided your career direction. So I lost focus in class 11 and regained focus in class 12.
What I am saying is that I considered the cost of each of my poor performance to be very low. I could always make up if I want to, I justified my inconsistency to myself. I was like Portfolio C in the above example, doing well sometimes, and doing badly at other times.
That pattern has been followed in most of my adult life. Give me a challenging job, I do well. But I go through the routine work at a very slow pace. I love working on projects since they are time bound and are filled with a lot of intellectual and interpersonal challenges. However, I don't do that well when it comes to routine activities, which are also very important.
Another example. My weight fluctuates between 80 and 87 Kilos. Every time it touches 87, I go to gym, I diet, I walk a lot.... Past experience has shown me that these strategies will be successful and my weight will ultimately reduce to 80, which it does. The problem is that once it touch 80, I stop the activities. Though I don't binge and all that, I go slow on all those strategies that helped reduce my weight from 87 to 80.
If you are a reader of one of MY BLOGs, you will see this inconsistency in action. My month-wise number of blog posts reads like Virat Kohli's test match scores in England ("Kohli's scores in the past 11 innings including Wednesday's blip read, 1, 8, 25, 0, 39, 28, 0, 7, 6, 20 and 0"). In some months I have written more than 30 posts and in others Zero.
This pattern is as regular as a clockwork. How is this inconsistency affecting me in the long-term? I have never even tried to analyse.
After reading the above math, I have come to realize the tremendous cost of my inconsistency. They (inconsistencies) pile up, they compound and I am sure that they have cost me huge opportunity costs over the long-term.
It is said that awareness is the step before change. While I was always aware of my inconsistent behaviour, the above example helped me become aware that I may be paying significant opportunity costs for the inconsistency.
I am sure that I am not alone. Many of us perform with inconsistency, and still may be successful in what we do. We get lazy, we are not in the mood, we lose our mojo, we procrastinate....reasons abound. This post is to help all of us see how better we can perform, how huge our returns will be, if only we were to add consistency to our recipe.
Wish you a consistent life.

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