Compounding: The 8th Wonder That Requires Time, Patience, and Faith

One would have probably heard the saying before - “Compounding is the eighth wonder of the world. He who understands it, earns it.  He who does not, pays it.”  This quote has been repeated endlessly in the personal finance world, and for good reason.

But here is the truth.  Compounding is not a get-rich-quick strategy.  In fact, in the early years, it can feel like watching paint dry- boring, slow and unmotivating.  You put in the effort, you save diligently, you reinvest your dividends, and for the longest time, it seems like nothing much is happening.  I have written a similar, but simpler post when I first started blogging back in 2022, where I noted 3 main factors affecting the compounding effects, namely time, yield and capital.

The Key Factors That Influence Compounding’s Power

1)     Time

This is the biggest multiplier.  The longer your money stays invested, the more time each dollar has to grow on top of previous growth.  Most people underestimate how much happens in the later years.

2)     Yield/ Rate of Return

The difference between 5% and 8% may not seem like a lot in the short term.  But over 30 years, that gap becomes enormous.

SGD 100,000 compounding at 5% for 30 years = SGD 432,000

SGD 100,000 compounding at 8% for 30 years = SGD 1,006,000

That is a million dollars from doing nothing but letting time and return compound.

3)     Initial Capital and Consistency

The fact is, $100 compounding at 10% is not going to change your life anytime soon.  However, starting with SGD 100,000 or even SGD 300,000?  That is when compounding begins to feel meaningful.  The more you have, the more each percentage point counts.  I like to think of compound interest as a snowball.  You want a big enough snowball to begin with, and you want a long enough hill for it to roll down.  Time and capital together build momentum.

From the 3 factors discussed above, capital amount is highly dependent on individual's earning power and savings rate.  To most investors, the initial capital should come from savings from active income.  Yield is one factor investors can somewhat control, depending on what instruments are used to compound our wealth.  Be it ETFs or dividend-paying shares, investors can structure their allocation mix to churn out a portfolio that pays a satisfactory dividend yield (or growth rate).  However, time is one factor that is mathematical and quite independent on individual's investing abilities.  So, how many years does it take before compounding starts to show its real power? And what factors influence when compounding begins to make a real difference?

The Truth About Time: When Does Compounding Feel Real?

Frankly, the first few years of compounding are boring.  If one is starting out with, say, SGD 100,000 and compounding at 5% annually, your portfolio grows to about SGD 127,628 after 5 years.  Not bad, but certainly not life-changing.  Stretch that same 5% return over 10 years?  One will be looking at $162,889, which is still modest.

Fast forward to 20 years, and the amount becomes SGD 265,330.  That is when the curve starts to steepen.  By Year 30, the amount would have grown to SGD 432,194, more than a fourfold increase, and that is when compounding starts to feel powerful.

So in my opinion, it takes about 15 to 20 years before compounding stops being a whisper and starts roaring.  Simply put it, one will need to let time do the heavy lifting, and that is why the earlier one starts, the better it is.  

However, do note that the above only considers the effect of compounding to a lump sum, with no further injection of capital along the way.  As such, if an investor combines the effect of compounding with dollar cost averaging (DCA), this may turn out to be a powerful turbo-charger to one's portfolio in the long term.

For myself, my current portfolio has only compounded by 7 years and 7 months.  Though it is only at half the time, I am contented with how my portfolio has grown.  Do not get me wrong, I am not a multimillionaire, my portfolio did not grow by multiple times.  In fact, my portfolio has only grown by about 40%, which is considered to be growing at a slow pace.  However, I am not too concerned by its growth as I am running my own race, and I do not see any point in comparing with others.  As long as my portfolio grows to a point where it can sustain my lifestyle, I am contented with the outcome.  Just continue to strive towards my eventual goals.  

Final Thoughts: Be Bored. Be Patient. Then Be Amazed.

Compounding is simple, but not easy.  It rewards the patient, the consistent, and those who keep the faith, even when nothing exciting seems to be happening.  There are no fireworks in the first 5 or 10 years.  However if you let compounding work quietly in the background, you will wake up one day and realize that the majority of your wealth was built not by you working harder, but by your money working for you.  As Warren Buffett put it, "If you do not find a way to make money while you sleep, you will work for money until you die".

So start early.  Invest consistently.  Stay invested.  Ignore the noise.  Add fuel when you can.  Let time do the heavy lifting.  Because one day, you will look back and say: “Wow!  Compounding really is the eighth wonder after all”.  Barista FIRE, here I come...!