Compounding: Investing in Siblings

I was lucky to learn about the power of compounding at a relatively early age – 19 in my case. I wish I had learned about it sooner because I would have acted sooner. Not that I had any money before age 19 because I grew up in the bottom rungs of poverty by American standards, but I would have certainly better prepared myself. I know this to be true because the day after I learned about the power of compounding, I immediately opened a Roth IRA and deposited the leftover financial aid money I had in my bank account from school. This was practical because I had sufficient income through work and the Marine Reserves. Since then, I now invest religiously and my money has grown significantly.

For those who are not familiar with the power of compounding, it is usually associated with the long term benefit of stacking gains on top of gains. The simple example is with an investment of $100 that earns 10% growth. In year one, you will have $110, but in year two, you will have $121 because the $10 earned in year one now earns 10% or $1. The stacking of these additional $10’s and$1’s over time is astronomical. In fact, Albert Einstein, founder of the General Theory of Relativity (E = MC^2), which explains so much about our universe and sorta the father of the atomic bomb, is quoted as saying the most powerful thing in the universe if the power of compounding.

Beyond investing, compounding simply refers to the aggregation of parts to make up something that is greater than the sum of its parts. For example, if you play the guitar, then your friend joins you with a bass, then another friend joins you with voice; you have just compounded 3 musical skills together to create a band.

I apply this thinking in a very nerdy way when I play computer games, especially games where you develop skills such as Role Playing Games, RPG’s. In RPG’s as one progresses through the game, you must allocate skill points to specialize your character and become more powerful. I almost always gravitate to skills that enhance my ability to gain more skills faster or over power a particular ability.

Now, back to the real world for yet a different example, and the purpose of the posts’ title. I apply compounding to “Investing in my siblings”, and it just paid off. My brother is a recent college grad. He just got an amazing job offer out of the blue with zero effort and now earns more than I. As a sign of the times, he was forced to accept a contractor role after graduation, but I insisted that he move away to a high cost of living city to better position himself for opportunities. Against parental wishes, he moved. One day an acquaintance via text messages tells him to await a call from a recruiter. The next day a recruiter calls, exclaims how even though he does not have a resume, lacks work experience, is in no way qualified for the field, and there is a large pool of qualified applicants, he is getting the job. They immediately negotiate a very favorable wage and he is asked to start work the next day! His manager at the contractor position was very supportive, offering to take him back if things did not work out, but life is working out just fine. He is shining at the job and I will emphasize again that he now earns more than I.

How did this happen aside from pure luck? To some degree I believe some luck is self made by positioning oneself for opportunities and keeping a positive outlook to spot them. However, I actually did a lot on the back end by providing financial support to subsidize the higher cost of living, allowing him the chances to socialize without worrying about making ends meet, and retirement investing to take advantage of the financial form of compounding to secure his future and create a sense of financial independence.

I think I am a reasonable example of the Horatio Alger “Rages to Riches” story, but in reality most wealth and success is inherited and is passed from generation to generation. Those with socioeconomic means are able to send their children to the best schools, invest in trust funds, and focus on development instead of scrapping by. It’s a sad reality that the Gini Coefficient, an indicator of income inequality, of America is actually higher (worst) than China(!), but I can’t help but think of the ways this plays out in society. The intern that’s able to work in the metaphorical mail room at Goldman Sachs but can still afford $1K nights out with the Investment Banker friends who eventually help him land a job, or the ability for top universities to raise tuition prices way beyond the rate of inflation year of year because the high price of admission allows the rich but not as capable students to subsidize opportunities for the talented but financially distressed students.

As a take away, I think optimizing compounding effects keeps the wealthy wealthy and even though it may seem insurmountable to build any level of security to rival the ultra rich, there is no need. One can simply look for the opportunities to apply compounding in your own life and be still find great happiness.

-fp

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~ by fp on January 26, 2013.

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