1. Understanding of Compound Interest

Suppose you currently have 10,000 yuan, and the interest rate is 10%. Then, next year it will become 11,000 yuan. If the interest can also generate interest, which is the so-called "compounding interest," then by the second year, you will not only have 12,000 yuan but 10,000 multiplied by 1.1 multiplied by 1.1, which is 12,100 yuan.

By the Nth year, your wealth would be 10,000 multiplied by (1.1 to the power of N), which is called "exponential growth." This is the so-called compound interest. With a 10% interest rate, it can reach 10 times in 25 years. That is to say, if you deposit 10,000 yuan now, you can get 100,000 yuan without doing anything in 25 years. If the interest rate is 15%, it can reach 10 times in just 17 years, and 100 times in 34 years! If your parents had deposited 10,000 yuan for you the year you were born, by the time you are 34, you would already have 1 million yuan. If they had deposited 100,000 yuan, you would have 10 million. If the interest rate is 20%, it can become 100 times in just 26 years.

In terms of personal growth, there was also an interesting experiment. Suppose your current level is 1, and there are three scenarios:

The first scenario: You muddle through each day without making any progress. What is your level value after a year? It remains the same, which is 1.

The second scenario: You learn a little bit each day, making a 1% progress every day. What is your level value after a year? It is 37.78 (1.01^365 = 37.78).

The third scenario: You regress a little bit each day, regressing 1%. What is your level value after a year? It is 0.025 (0.99^365 = 0.025).

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Those who strive a little bit every day will be 38 times better than they were a year ago, while those who regress even a little bit every day will deplete their talents.

When we see these, our hearts tighten. Indeed, compound interest is the craziest existence in the world, and it seems that financial freedom is beckoning us. It also seems that the motivation to read books and memorize English every day is getting stronger.

2. The possibility of making a 1% daily progress and achieving a 10% annual investment returnFirst, consider the possibilities of a business. The growth of a business can be divided into three stages: infancy, expansion, and maturity. During the infancy stage, the company has just started and may not be profitable for a considerable period of time. If you persist, one day when the new product opens up the market, the company will enter a period of rapid growth known as the expansion phase. The growth during the expansion phase is very much like exponential growth.

Users bring word-of-mouth, and word-of-mouth brings new users; the whole process is a positive feedback loop. However, this exponential growth will not last long! Your growth rate will quickly decline and reach a plateau, which is equivalent to a mature company. Why is it inevitable to encounter a plateau? Because the market is limited. One day, competitors will catch up, or you will find that everyone in the country who might buy your product has already bought it, and your marketing efforts have reached their peak. Without innovation, sales revenue will enter a bottleneck period, also known as the S-curve.

For individuals, the idea of "improving 1% more than the previous day every day" is extremely unreasonable. Some might argue, but I can memorize 5 words a day, right? Memorizing 5 words a day, over a year you can memorize 1,825 words, which is linear growth, not exponential growth. The mistake here is to calculate something that should be done with addition using exponentiation.

Looking again at the case of a 10% annual compound return on investment, Warren Buffett made a bet in 2005, saying to these confident financial experts, don't boast all day long, I'll put up $1 million, you can choose any 5 funds, and if their 10-year return can beat the market, I'll consider it a loss.

Ten years later, when the bet expired, the S&P index had grown by 85.4%, while the total 10-year return of the 5 funds selected by Wall Street fund managers was: 8.7%, 28.3%, 62.8%, 2.9%, 7.5%. The best performance of 62.8%, when calculated using the compound interest formula, translates to an annualized return of only 5%. So now you understand, a long-term stable high return is almost a fantasy.

Even professional fund managers find it difficult to achieve, so it is even more challenging for ordinary individuals to achieve a 10% compound annual return.

The core of the compound interest formula, "high return rate," does not exist in most cases.

3. Relying on compound interest to get rich is a form of cognitive laziness.

Assuming a person starts to deposit 1 dollar in a bank at the age of 22 after graduating from university, and continues to deposit until retirement at 60, with interest continuously rolled into the principal, after 38 years, according to the effect of compound interest, his initial deposit of 1 dollar would become 1.76 dollars. Yes, you are not mistaken, the total return after 38 years is only 76%. This result may disappoint many people, but we must face reality. The speed of compound interest is far less optimistic than we imagine because it is easy for us to overestimate the number of periods. You think you can easily multiply by 365, but in fact, in a lifetime, you may only multiply by 38.

If you assume an annual return rate of 10%, the compound interest effect after 7 years is (1+10%)^7.2 ≈ 2, with a return rate of about 100%. Doubling in 7 years sounds good, right? So what if you don't use the logic of compounding interest? If you just leave the principal there and calculate with simple interest, the total return after 7 years is 10% times 7, which is also 70%, not much different from 100%. So don't overly attribute the results to the snowball effect of interest on interest. Over a 7-year period, most of your returns still come from your principal and basic interest, not from compounding interest. Too many people regard compound interest as a fast track to wealth.The compound interest effect is not a get-rich-quick scheme; rather, it is a concept that heavily relies on the long term. Compound interest requires a sufficiently long period to ferment and mature, which could span a lifetime or even several generations. In short, the compound interest effect is absolutely not something that can be realized in the short term for the vast majority of people.

4. Create wealth, not rely on wealth to create wealth by itself

The value of compound interest is more reflected in personal growth rather than in the narrow sense of wealth. For individuals, at the starting stage, you must exert all your efforts to maintain rapid growth, striving to break through the threshold in the shortest possible time and enter an accelerated process. This is the only way to reap the benefits of compound interest in the later stages. Choose the right track, accelerate, and keep accelerating until you break through. For individuals, it is crucial to learn the correct methods first, overcome various delusions about different investment products, and invest your time in yourself. Understand early on that high-yield compound interest cannot grow indefinitely, and most individuals cannot beat the market.

Secondly, having a sufficient principal is very important. When you are young, do not always think about saving money. Perhaps you can be disciplined enough to skip a hot pot meal or a movie, but it does not have a significant impact on achieving financial freedom for yourself. Cultivate your ability to earn money, relying on the principal, not on compound interest. Without a sufficiently large principal, the effect of compound interest is minimal.

Again, a steady return is the foundation of wealth growth. It is not difficult to see that many wealthy people still consider annuity insurance with a 4% return from insurance companies to lock in returns in advance. Therefore, there are not that many 10% annual compound returns in the world. If there were such institutions, everyone would probably be clamoring to give them their money to manage. Thus, it is essential to have the ability to recognize the risks behind such offers. You are focused on the interest of others, while others are focused on your principal.

Time is a lever, but the lever also needs to be sufficiently long. Be patient with time and use it as a lever to understand that compound interest has never been a means to get rich quickly. There is no need to mythologize the exponential amplification effect of compound interest. However, investing in yourself throughout life, accumulating a lot on the right track, and waiting for the day when your efforts pay off in a big way is also a path that brings you closer to financial freedom.