When you read a lot of books on success or watch a lot of videos about self-improvement and the like, like I do, you probably have heard about the “compound effect”. I don’t mean the book, I mean the phenomenon. It’s that positive results compound over time—like compound interest—and increase your success exponentially. Well, while this sounds appealing and might be true in theory, there are several reasons why it might not work out to make you “massively” successful, as the authors claim.
Small Interest or the negligible effect of your effort
Compound interest is often used as a comparison when talking about making incremental small steps to success. And as it turns out, the comparison is also quite useful when we talk about the flaws of this success building strategy. The thing is this: The long term effect relies heavily on the interest rate. So if you invest 100 € every month and have an interest rate of 1 %, then you end up with 12625.5 € after 10 years. Your total amount of interest (including compound interest) was only 625.5 €. Not exactly my definition of “massive” success.
And you can think about it in terms of real world problems, too. Consider you want to find friends, and you need to reach out to 10 new people and make on average 10 positive interactions with each of them to win one new friend. That makes a 100 interactions for a new friend (I made those numbers up, so don’t assume that’s an algorithm for winning friends). If you have time once a week (typically on weekends), because the rest of the week you are working, you need two years to win a new friend. Because you have a new friend now, he can introduce you to other new friends. So the number of necessary interactions might drop to 90 (that’s the compounding effect). You will still end up with not much more than 5 friends after 10 years.
So what you always have to consider is that the interest or dividend or return from your effort might be so small, that there is no significant gain to even notice a compounding effect. Which does not mean, that you should not put in the effort, because you still have about 5.5 friends and 12k € after 10 years. It’s better than nothing. It just means you should not be fooled by exponential expectations.
Inflation or the rising demand of the environment
Another thing with compound interest is inflation. If your interest rate is 1 %, but the inflation is 2 %, inflation eats up all of your interest and parts of your principal. You end up worse despite the interest payments.
Coming back to the real world: If you manage to increase the productivity of your company by 1 %, but the market demands (through competition) reduce the price expectation by 2 %, you will reduce your margin and make less profit despite the gain in productivity.
The moral of this story is again, that you probably should increase your productivity, because if you wouldn’t, you would fall behind even more. It’s just important to realize that only maintaining a certain position can be so challenging and expensive that it might be the best you can expect.
Loss of principal or the speculative nature of every investment
This is probably the most painful one. So if you e.g. invest in the stock market to receive your annual 7 % of growth, it is not unlikely that you end up with less even after 10 years. Investments are risky by nature and expecting things to grow unconditionally, just because you were so “smart” to invest and not to spend, is naïve.
In business life, this also holds true. If you invest your time and money, to automate a business process, the automation might never be completed or never work properly and you end up losing the full investment.
The conclusion here is to carefully evaluate every investment and assess its risks. Being very selective and careful with investments is actually a rational approach.
What bothers me, is that the majority of self-help-success-building literature conveys the impression, that the simple decision to make long-term decisions will somehow magically lead to “massive” life-changing success and happiness. Well, sorry folks! That’s not the case.
There is actually a case to be made for immediate rewards and immediate results with no long-term perspective, because of the above mentioned flaws of the compounding idea.
With that said, I still believe that compounding can happen and it can benefit you in your life and work. But it will most likely not be massive, it will probably not be easy, and there will be a lot of pain along the way.
Being very careful and sceptical about “long-term” decisions, considering the net effect and looking at opportunity costs is probably a smart decision.