Albert Einstein, one of the world's most famous physicists and mathematicians, once described compound interest as the Eighth Wonder of the World, saying ‘he who understands it, earns it … he who doesn't, pays it’.

Warren Buffett, universally regarded as the most successful modern-day investor, concurs: ‘My wealth has come from a combination of living in America, some lucky genes and compound interest,’ he explained along his journey of amassing a net worth exceeding $87 billion. So, if there's one sure fire way to become a bulletproof investor, it's to grasp the genius of compound interest/growth.

At different stages throughout school and university, I learned the basic premise of compound growth. At that time, it didn't stand out or strike me as being overly significant. In terms of practical application to real life, it probably ranked alongside algebra — very low! However, Uncle John proclaimed compound interest as the most important concept to understand if you want to achieve financial success.

By this stage of my apprenticeship (I was about 21 at the time) it had become very clear I was never going to be able to save my way to financial independence. (Remember my sums: put aside 10 per cent of my pay packet for 192 years and I might get to where I want to go.) In that scenario, I feared the clock would beat me! But what if I could buy more than one property — that is, have multiple assets all increasing in value at the same time? Have them working together? That, in a nutshell, is what compound growth is all about.

Compound growth is growth on growth — as opposed to simple growth or simple interest. A friend once described them as the difference between speed and acceleration. He likened simple growth to speed and compound growth to acceleration. With simple interest, if you invest $1 for 10 years at 10 per cent interest per year, your dollar will grow by 10 cents a year. On those calculations, in 10 years your initial dollar would be worth $2.

On the other hand, compound growth earns interest on your dollar and on the interest. Using the same scenario, by investing $1 for 10 years at 10 per cent per year, at the end of year 1 your dollar is worth $1.10. But in year two it grows by 11 cents. So the total value is now $1.21. At the end of 10 years, the same dollar is valued at $2.59.

That might not sound like much of a difference — until you do the same exercise with much larger numbers and see what the equation looks like. For example, if you had $1 and achieved a 100 per cent return (simple interest) every day for 20 days, at the end of the exercise you would have a sum total of $21. If your $1 compounded on itself at 100 per cent, at the end of the 20 days your $1 would be worth $1 048 576.

John has told me thousands of times, ‘Show me a successful person and I'll show you someone who has a set of successful habits that they practise and which also give them a successful formula for achieving compound growth. It doesn't matter whether they're an athlete, an artist, a businessperson or an investor — I'll bet they're using the basic principle of compound growth.’

Apple, one of the world's biggest and most valuable companies, sold its first iPhone in 2007. In 2009 it sold 5.41 million iPhones. In 2019, it sold 194 million iPhones, having sold a total of 2.2 billion iPhones between 2007 and 2019. That's compound growth in action, right there.

Warren Buffett's company, Berkshire Hathaway, went from having $185 million worth of assets in 1980 to owning $817 billion worth of assets in 2020. In 1980, you could buy a single share in his company for $290. The same share today is worth $327 000.

So how do we use compound growth?

Compound growth and property

Let's look at the Eighth Wonder of the World more closely.

Going back to our example in chapter 12: in table 12.4 we looked at buying a property for $500 000 that, in 10 years, would be worth $1 000 000. To buy it, you borrowed 90 per cent of the property value, investing $80 000 of your own money. That investment of $80 000 grew to $550 000 in 10 years.

From this point forward I’ll be referring to the value of your investment in the property as ‘equity’. Equity is the value of an asset owner’s interest in the asset after all debts are accounted for. In our case, it will be the value of the property less any debt owing to the bank. Again, going back to the example in chapter 12, although we invest $80 000 into property number 1, the ‘equity’ in that property at the time of purchase is $50 000 (being the difference between the $500 000 property value and the debt of $450 000). The difference between the $50 000 in equity and the $80 000 investment relates to the $30 000 in purchase costs that don’t contribute to the value or equity in the property.