Imagine that you get up late one day and make it to the bus stop 15 minutes later than normal. But while waiting for the bus, you meet your future spouse with whom you are going to live a beautiful life. This happened just because you woke up late one day. An event that seemed insignificant at that time had a significant impact on your life.
Now imagine another situation. You work in a small company where you are mistreated by your boss. After months of being disrespected, you start to hate your job and decide to quit.
Before you quit, you speak about your experience with other employees and the result is that three other people decide to quit too. When these people find themselves unemployed, they decide to start their own business. After some time and a lot of hard work, their business becomes successful to the extent that they start competing with the company they used to work for. Under pressure of fierce competition, the old company declares bankruptcy. In a way, it all started with you quitting your job.
These two situations seem exceptional but that is what happens to a lot of people a lot of times – a small, hidden force causes a big effect in their lives.
This hidden force that causes small, insignificant events to cause big, significant outcomes is called the “butterfly effect”.
The Butterfly Effect
The butterfly effect is an idea from science that describes how small events can end up creating huge impacts. It comes from the idea that the flapping of a butterfly’s wings in a continent could theoretically alter the path of a hurricane several weeks later, and in another continent.
Now, why am I talking about the butterfly effect, and insignificant events causing big outcomes on a website dedicated to money and investing?
You see, the butterfly effect is a tremendous force that can alter the course of your financial life too, like it did with my personal financial life starting 10 years back.
How did it happen?
Well, to most people, a thousand rupees spent is just that – a thousand rupees they don’t have anymore. Spend one thousand rupees at a restaurant or a mall, and you’re less wealthy by one thousand rupees.
But this is not how I’ve looked at spending over the past 10+ years.
I’ve looked at spent money with the butterfly effect in mind. The more I spend, especially on things I can live without, the more I surrender my ability to compound my wealth for the next 15-20 years. This can cause ripple effects over the course of my life.
So, I understand that an insignificant event of spending Rs 1,000 now can cost me a significant Rs 16,000 that I can make of that Rs 1,000 by earning 15% annual return on it over the next 20 years. A simple math but a startling fact, isn’t it?
If I can comfortably do with a car costing Rs 6 lac instead of giving in to the temptation of buying a car worth Rs 12 lac (just because my neighbour has it!), and I compound this Rs 6 lac of saving at 15% for the next 20 years, I would end up with almost Rs 1 crore of extra savings.
So, the decision to buy the lower-priced car means I would end up with 16 times more money than I saved. A massive impact of a relatively much smaller cause!
Consider another example. Opting for a mobile handset worth Rs 15,000 instead of one priced at Rs 50,000, you save Rs 35,000. This, when invested at 15% annually compounded return for 20 years would amount to about Rs 5.7 lac!
A few seemingly small saving decisions can produce huge difference in your level of wealth over the long-term.
Now, imagine making hundreds of decisions – big and small – to save and compound instead of to spend and consume over the course of your life. Choosing to save Rs 500 here, Rs 5,000 there, and Rs 50,000 there can have a huge impact on your future life.
Choosing not to spend such amounts – small and big – at several occasions has helped me add an extra Rs 25 lac to my wealth over the last few years.
Compounding is a Snowball
Look at compounding small sums of money like rolling a snowball down a hill. As the snowball gets larger, it’s able to gather more snow, which enables it to get larger, which enables it to gather more snow, which enables it to get larger…and so on.
Compounding is the ultimate way to turn a little money into a lot of money. It’s the greatest secret of wealth creation.
Especially when you’re young, compounding is an important concept for you to learn and implement because you have the power of time on your side.
Time, is in fact, the most important part of the compounding equation, even more important than your rate of return. The longer you can compound, say even a 10% rate of return, the more extraordinary would be the results.
Please don’t get me wrong here. I’m not saying don’t spend any money. Instead, I suggest you spend money on experiences – to enjoy a nice dinner with your family, or a vacation. The ultimate idea is to enjoy life till it exists.
What I’m simply saying is that if you want to become wealthy, don’t go into frenzy with your spending. Stop spending on things you can live without.
The next time you’re thinking about spending a few thousand on something you don’t really need, remember the butterfly effect of spent money. You won’t be letting go of just a few thousand rupees, but missing out on the huge wealth that compounding can produce for you over the long-term.
Starting 2015, if you can keep this in mind and practice diligently, you’ll thank me in 2025. 🙂
The butterfly effect has helped me earn my financial freedom. I see no reason it won’t help you achieve yours.
P.S. Here is the article that inspired me to write this post.
Here is a beautiful video on snowball effect.
Thanks for sharing this, Ragu!
Hi,
A significant part of this article has been taken from an article of an US based reasearch firm. It is a useful article.
Thanks Ajay! Not a significant part but largely the thought is what I have borrowed. I have given the credit to that firm at the bottom of the post. Regards.
Hi Vishal,
Very nice article. Compounding is the way to be wealthy. Also I’ve found out a small trick – I ask before buying anything “Is it my necessity or desire?”
Also, would like to know whether you’re “financially free” now?
Thanks,
Avadhut
Thanks Avadhut! For your question, please refer to my reply to Mr. Ramesh. Thanks!
How do you call yourself financially free? Have you completely stopped working for money (even not charging money for doing things that you enjoy)?
Financial freedom is NOT about ‘not working for money’.
It’s the freedom that allows me to enjoy life while not worrying about money. It’s about doing what I want to, not what I have to. It’s about spending more time with my family, reading, and travelling, than working for money. It’s about having no IOUs. It’s about living happily on less. It’s about having nothing to do with what others are doing, earning, and buying.
It is also about being generous which keeps me from being too attached to money, which is the greatest freedom of all.
In these ways, I am financially free. 🙂
You have articulated it well Vishal 🙂
some thoughts
a) where can one find 15% cmpd retn for 15 yrs?
b) what are you saving your 1 crore for at an age where enjoyment avenues will be marred by health issues
c) you are not financially dependent if you are during a lavish dinner trying to save and not buy the best wine/food/desert – you miss enjoying the moment.
15% yes.. easy! Mutual funds will give you.. that too Tax free!
one example: HDFC equity return since launch 21% yearly! Launch date Jan-1995. See here.
Save ,invest with compounding effect and become wealthy in future.from my experience i confidentially say it certainly works.
I wonder where does Donating for some good cause fit in? I think One should not be too much carried away by this “Compounding” on that.Of course you have implicitly covered under”JOY”; Certainly it includes “JOY of GIVING”
Vishal,
Though, this is not directly related to the topic – it is indirectly related and hence taking the liberty to share a query (or rather dilemma) – which I have been dealing with for past 2-3 years, since I started to understand what financial freedom is and the challenges to achieve one.
If I have a small housing loan of Rs. 10,00,000/- extended by a bank at fixed (note – fixed till end of the loan tenure) at 7.25% – should I pre-close the loan now OR rather continue the loan till end of the tenure ?
Everytime (and this happens once in 5-6 months) I look at my portfolio (including the debt part), I face this question – and the fact that my FD is earning 9.5% (and no tax involved – don’t ask how) stops me from pre-closing the loan.
Probably, I am looking for a second opinion – with Vishal and so many other experts here and with my limited (or hardly any) experience in finance management, it will help strengthen my belief in my goal and slow journey towards achieving financial independence.
Thanks in advance,
SP
Not spending and saving that money is one part (maybe th easy one). The oter part is to invest that money wisely.
Regards
Chirag
Rightly put. Saving is the 1 part. But like one crutch, if not put to into its proper place It is of much use.
(correcting the typos in my earlier comment)
Not spending and saving that money is one part (maybe the* easy one). The other* part is to invest that money wisely.
Regards
Chirag
Thanks Vishal. You have successfully changed my way of thinking. I will also think this of this concept before spending. In fact, I think WB owes a lot of his wealth to the power of compounding.
Vishalji,
Very nice article.
What an incredible artilce 🙂 ..
Extremely powerful words and examples giving the full essence of financial freedom and how to get there. Very well written Vishal 🙂 . Even the way you have defined financial freedom in one of your comments is awesome. I also find myself in that same situation at the moment like you and can totally relate to it 🙂
Nice job . Lots of learning on how to craft your writing ..
Manish
Whoa! What a great start to the day to read your comment, Manish! You yourself are an inspiration to so many. Thanks! Regards.