Investing 101: Why Invest? Part-2

This is part 2 of a multi-part beginner series for Why and How to get started investing. I will try to lay down my motivation for investing, tools and practices to find great companies/startups that create enormous value for society and in turn the shareholders.

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Compounding

Eienstine called it the 8th wonder of the world. The power of compounding is very powerful.

The most common example cited to demonstrate how large numbers can get is Story of an emperor who almost lost his kingdom:

The game of chess originated in India during the 6th century. The clever inventor took his game and presented his invention to the emperor. The ruler was so impressed by the beautiful and difficult game that he invited the inventor to name his reward. The inventor, being a clever guy, if not he couldn’t have invented chess, asked ­“All I desire is some rice to feed my family”.

Since the emperor’s largess was spurred by the invention of chess, the inventor suggested they use the chessboard to determine the amount of rice he would be given.

“Place one single grain of rice on the first square of the board, two on the second, four on the third, and so on,” the inventor proposed, “so that each square receives twice as many grains as the previous.” ­

The emperor didn’t study Moore’s Law (Another great exponential model). So his brain couldn’t see the power of compounding at high rates of growth. Without thinking further he agreed to the inventor’s requests. If the emperor request were fully honored then the inventor would have taken home eighteen quintillion grains of rice. How much rice would that be? That much rice would dwarf Mount Everest and it’s more rice that has been produced in the history of the world. The emperor realized his stupidity and he got the inventor beheaded.

I think compounding is one of the primary reason to invest. $1,000 invested with a return of 10% will be $1,100 in one year, $2,584 in 10 years, $4,178 in 15 years and $6,728 in 20 years.

Our brain can’t understand exponential growth. The default wiring of our brain supports linear thinking. And it’s not well equipped to understand sustained exponential growth. We severely underestimate how big numbers can get.