Compound Interest: Building Advantages That Others Can't Catch

You’ve certainly grown tired of hearing the words “compound interest,” but we must discuss it specifically one more time. People have many misunderstandings about compound interest and often fail to grasp the key point.

You won’t achieve financial freedom in forty years simply by saving the price of a cup of coffee every day. No matter what project you practice, you cannot be 1% better than the previous day for 365 consecutive days — all growth has an upper limit. And Einstein never actually said that “Compound interest is the most powerful force in the universe” [1].

Life isn’t that simple. However, compound interest is indeed an extremely useful and strategic tool. It specializes in multiplication, allowing you to accumulate advantages that others cannot catch up with in the short term.

Compound interest isn’t just a financial tool; your most important capital likely isn’t money. But money is easier to understand, so let’s start with two stories about money.

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By the time Warren Buffett turned 89, his net worth was $84.5 billion. For the average investor, this is an unfathomable number. But if you examine the average annual return of Buffett’s entire investing career, it’s about 22%, which sounds less absurd. When you’re lucky, you can earn 22% in a year, right? Buffett’s success isn’t because the interest rate was high [2].

In fact, the top hedge fund on Wall Street, Renaissance Technologies, had an average annual return of 66% from 1988 to 2020, which is far superior to Buffett’s.

Yet, Jim Simons, the founder of Renaissance, has a net worth of only about $20 billion, just a quarter of Buffett’s.

Why? Because Buffett’s investing career started at age 10, whereas Simons only found that magical algorithm at age 50.

In compound interest, the most important factor for success isn’t how high the rate is, but how long it sustains.

Let’s look at a more down-to-earth thought experiment. Imagine two students, Xiao Zhang and Xiao Li, both starting work at 25 and retiring at 60. Their investment returns are both 8% annually. Xiao Zhang starts investing 1,000 yuan every month as soon as he starts working at 25 and continues until 60, investing for 35 years in total. Xiao Li starts 10 years later, only thinking of saving at 35, but he works hard to catch up, investing 2,000 yuan every month until 60.

Xiao Zhang invests a total of 420,000 yuan in principal over 35 years, while Xiao Li invests a total of 600,000 yuan over 25 years. Who do you think has more money at retirement?

The answer: Xiao Zhang has 2.29 million, and Xiao Li has 1.91 million.

Starting early is much more important than investing more. Time is something money cannot buy.

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This is the magic of multiplication — or more precisely, exponential growth. “Compound interest” means interest is not only calculated on the principal but also on the interest that has already accumulated.

At age 35, Xiao Zhang has already accumulated a large multiplier, an advantage that Xiao Li cannot quickly catch up with even by running faster.

Whether saving or borrowing, compound interest is a magnification machine made of time. You want to stand on the side of accumulation rather than debt, but first, you hope to be able to use this machine.

As we discussed before, the reason this world is heavy-tailed and why there is such a large wealth gap is that some people live in a multiplicative world while others live in an additive world. The key difference between the two is whether they utilize compound interest.

French economist Thomas Piketty proposed a famous relationship in Capital in the Twenty-First Century:

r > g

Where r is the average return on capital (compound interest rate), and g is the economic growth rate (roughly corresponding to the pace of wage and GDP growth).

If you only work for a salary without asset income, your income will grow at the pace of g — roughly at the rate the Chinese economy grows each year. But if you have asset income, such as wealth management products, stocks, or real estate, your assets grow at the rate of r. r > g means that, generally speaking, the speed of “money making money” is faster than “people making money”… Piketty says this is why those dressed in fine silks are not the ones who raise the silkworms.

So why r > g? Perhaps because labor is limited by the human body and physical boundaries, while capital can tirelessly roam the world seeking high-return opportunities; or perhaps because risk and patience must have a premium.

The point is, the wealth gap isn’t because the rich are evil or the poor are lazy, but because the rich can use compound interest. They are playing a different game.

Or rather, it’s because the advantages of the rich are accumulable, whereas selling labor is not.

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Hearing this, you might say, “But the multiplicative world requires taking risks.” After all, there’s no long-term investment that guarantees a fixed 22% rate every year. Exactly. The chart below shows Buffett’s performance since 1981 —

Buffett’s career average annual return is 22%, but he doesn’t achieve 22% every year: sometimes he earns more, sometimes less, and sometimes he loses money. In fact, Buffett’s performance after 1999 was far inferior to before, but his wealth only became particularly dazzling after 1999… that’s simply because the previously accumulated multiplier was magnified.

The lesson is that the multiplicative world does indeed involve risk, which is entirely different from the additive world’s “one portion of labor for one portion of harvest.” Many rich people we see are examples of “survivor bias.” There might be many who used the same investment (or speculative) strategies but failed and exited early, never entering our field of vision… You have to find a way not to leave the game.

We’ll discuss risk management tools later. The key here is that interest rates are unreliable. The true secret of compound interest is longevity and starting early: it is a system that must exist long-term, not blow up, and maintain accumulation.

“Long-termism” is easy to say but very hard to do. Our daily intuition is based on addition — do a job, get paid, eat a meal, as if it’s natural law. Our brains are not very good at thinking about operations like “8% per year.” Today’s happiness is very real; future returns are very far away.

If you work for a formal American company, the amount of retirement savings you put in beyond social security will be “matched” by the company at a certain ratio — for example, if you save 5% of your total income, the company saves another 5% for you, meaning you get a double portion. That 5% is essentially free income you should save without a second thought, right?

Yet, a large number of Americans don’t save. Statistics show [3] that 18% of American employees with retirement plans don’t save a single cent, and another 31% save some but not enough to reach the full company match. They essentially prefer to spend more today and are willing to throw away free money. They only regret it as they approach retirement.

How can you talk to these people about compound interest?

In contrast, we Chinese are very good at delayed gratification. This is likely a congenital advantage of East Asian culture, possibly originating from agriculture or the imperial examination system. Both projects require you to maintain unilateral investment for a long time before reaping a harvest.

East Asian culture loves investing in education and saving money. This is indeed making friends with compound interest; East Asians are often the wealthiest ethnic groups wherever they migrate.

But these two tracks are perhaps too narrow. What’s the point of a life so arduous where one only does two things: get high scores on exams and save more money in the bank?

Compound interest shouldn’t only be used for exams and saving money; you can actually accumulate other advantages.

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French sociologist Pierre Bourdieu proposed as early as the 1980s [4] that “capital” is not just money; there is also cultural capital, social capital, and so on. Using this perspective, the following seven types of capital are all worth accumulating through compound interest:

First is Financial Capital: cash, stocks, and real estate. This is the most direct form of money. It’s easily quantifiable and inheritable but is often just a byproduct of other capitals.

Second is Human Capital: your knowledge, skills, judgment, and learning ability. Nobel laureate Gary Becker’s insight [5] is that the return period for human capital is particularly long, so the earlier you invest, the better.

Third is Health Capital: your physical fitness, energy, and chronic disease risk. Young people take health as a default, but middle-aged and elderly people realize that health is a durable capital stock, not something that can be solved by taking two supplements today.

Fourth is Social Capital: your network of relationships, and how much reciprocity and trust exist between you and others. Note Mark Granovetter’s “strength of weak ties” theory [6]: many important opportunities come from “friends of friends” rather than your closest circle.

Fifth is Prestige Capital: what is your brand value? What is the overall impression others have of your reliability? This is the most typical battlefield for the Matthew Effect: the better your reputation, the more opportunities come your way.

Sixth is Psychological Capital: including self-control, resilience, emotional stability, and a sense of meaning, especially conscientiousness [7]. Psychological capital is the operating system for the entire compound interest system; it determines whether you can consistently do the right thing over the long term.

Seventh is Experience Capital: what difficult things you’ve done, where you’ve been, and what you’ve experienced with whom. High-quality experience narratives settle into judgment, narrative ability, and identity. Scientists have long known [8] that experiential consumption increases long-term happiness more than purely material consumption.

These capitals are not contradictory. They can overlap and transform into each other.

For example, if you are rich in psychological and health capital, you are likely to be a highly reliable and long-term trustworthy person, which gives you prestige capital. Consequently, others are more willing to cooperate with you, giving you social capital. This, in turn, allows you to participate in many high-quality projects, accelerating your growth — which is human capital. And all of this constitutes excellent experience capital, while increasing your financial capital…

This is a beautiful positive feedback loop. Once the flywheel starts spinning, you’ll become addicted to accumulating compound interest.

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So you might ask, how do you choose when you need to accumulate so many things? Furthermore, you can’t just accumulate without consuming, or you’d become a machine.

First, accumulation itself is a joy, and good consumption is also a form of accumulation, at least accumulating experience capital. Accumulating compound interest is never just about saving money; it’s about reserving energy and investing attention and time. However, in different situations, there are indeed different priorities for accumulation.

Because the interest rates for compound interest vary. We modern people should develop an “ROI awareness” (Return on Investment): what you should accumulate most in a given situation depends on the ROI.

The chart below shows the ROI of several capitals at different ages, as interpreted by GPT —

Financial capital can be invested at any time, but investing in human capital is most worthwhile in youth. In middle age, social and prestige capital yield the highest returns. Health capital becomes increasingly important as one ages. Thus, if you are a young person with little spare money, don’t study stock market like Buffett; you should invest in yourself. And if you are a middle-aged person in good health, don’t rush into studying health preservation just yet.

Mathematically speaking, what’s most worth accumulating is the capital that can raise the interest rates of other capitals. Raise that first, and your subsequent accumulation of everything else will be faster.

Taking these into account, we can roughly plan a compound interest route for life:

18–25 years old is the “Rate Raising Period”: First, turn yourself into a system that upgrades quickly. At this time, spend as much money and time as possible on human capital. Even if you have to borrow some money, don’t let it hinder your studies; it’s best to go to a big city.

25–35 years old is the “Track Locking Period”: Pause broad exploration and select a high-compounding track to cultivate deeply. Significantly improve professional capabilities, establish industry prestige, and begin actively managing social capital. If you have extra money, you can start long-term investments.

35–50 years old is the “Scaling Period”: Ideally, your interest rate is already high, and your prestige and relationships have generated network effects. At this time, be good at using teams, systems, and tools to magnify yourself. Earn as much money as possible, but be careful of the risks of health and prestige dropping to zero.

50–65 years old might be the “Anti-Aging Period” or a “New Exploration Period”, depending on your specific situation at the time. Regardless, you should consider compressing your experience into transferable knowledge and outsourcing trivial matters as much as possible.

Generally, people retire after 65, which is roughly the “Dividend Period”, but perhaps you can continue to generate compound interest for your descendants and society.

In short, from the perspective of compound interest, strength in youth is growth; strength in middle age is leverage; and strength in old age is selection.

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Finally, I must tell you one more story. Discussing compound interest without this story would be like “talking big from a position of ease.”

Between 2009 and 2013, RTHK produced a reality show called Rich Mate Poor Mate. They invited CEOs of listed companies, second-generation wealthy individuals, lawyers, and other middle-to-upper-class people to live in cage homes and partitioned cubicles with almost zero cash, working as cleaners, street sleepers, and milk tea shop assistants, struggling at the grassroots level. The participants originally believed that as long as they had ability and fighting spirit, they could quickly turn things around from scratch — but after actually experiencing a “working poor” life of working 17 hours a day, with rent consuming more than half their income, and having to budget every single meal, their universal feeling was:

Poor people are busy making a living all day long, and they simply don’t have the time, energy, or safety net to learn or make long-term accumulations.

Not everyone has the conditions to accumulate compound interest. If you are able to accumulate compound interest, that is a tremendous stroke of luck that will bring you a massive advantage — and the advantage you accumulate will be something others cannot catch up with even if they have the conditions in the future.

Think back to the story of Xiao Zhang and Xiao Li at the beginning. Don’t waste this luck.

GPT, inspired by compound interest, composed a verse:

Treat money as seeds, not as spoils; Treat body and mind as soil, not as consumables; Treat relationships as climate, not as tools. The interest rate is within you, The compound interest grows in the system.

Notes

[1] Elite Daily Lesson Season 2, Chicken Soup of Compound Interest and Growth in the Real World

[2] Morgan Housel. The Psychology of Money. Harriman House, 2020. See also Elite Daily Lesson Season 4, Psychology of Money 2: There are only two ways to get rich in stocks, and, what Buffett doesn’t do.

[3] Vanguard. How America Saves 2024. Malvern, PA: Vanguard, 2024. https://corporate.vanguard.com/content/dam/corp/research/pdf/how_america_saves_report_2024.pdf

[4] Bourdieu, Pierre. “The Forms of Capital.” In Handbook of Theory and Research for the Sociology of Education, edited by John G. Richardson, 241–258. New York: Greenwood Press, 1986.

[5] Becker, Gary S. Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education. Chicago: University of Chicago Press, 1964.

[6] Granovetter, Mark. “The Strength of Weak Ties.” American Journal of Sociology 78, no. 6 (1973): 1360–1380.

[7] Elite Daily Lesson Season 6, Three Traits of Excellent Talents

[8] Van Boven, Leaf, and Thomas Gilovich. “To Do or to Have? That Is the Question.” Journal of Personality and Social Psychology 85, no. 6 (2003): 1193–1202.