Compounding

One of the most misunderstood and underestimated tools to improve the creation of wealth is compounding.

Compounding is what happens when one event occurs on top of the other. Compounding turns small isolated events into significant long term trends.

An example of positive compounding occurs when you make an investment that provides a positive return one year, and then a positive return in the next year.

In this case, you earn a positive return on your capital, plus you earn a return on the investment return of the year before.

Conversely, you could experience a negative return followed by a negative return, leading to a negative compounding experience.

The combined experience, return on return, is far more significant than one of the events by themselves.