Michael D.David : Compound Interest and the Egg
Let's dive into an example, I once came across a story that made a lasting impression on me. There was once a story about a person who got hold of an egg. Instead of eating it, he wanted to let it hatch into a chick.He planned to raise the chick so it could lay more eggs, leading to a cycle of chickens laying eggs and eggs hatching into chickens.... Wouldn't this lead to great wealth? But while he was dreaming of all this, the egg accidentally fell and broke on the ground. That egg hitting the ground was a typical accident, but it shattered his entire plan.
The concept of compound interest is prevalent due to a simple rule: as long as growth is maintained consistently, astonishing results (returns) will accrue over a long period of time.
However, we can liken the egg to the principal of investments. When the egg falls and breaks, it's like the principal becoming 0 due to unforeseen losses. So, how do we control the risk of losing our principal investment and minimize or eliminate that risk?
It’s like the old saying: “Don’t put all your eggs in one basket.” Investors should strive to understand the meaning of risk and assess its relationship with other factors. Long-Term Capital Management (LTCM), for example, ignored extremely rare events (commonly known as black swans), leading to massive losses and eventual collapse.
Moreover, I suggest investors cultivate the ability to think rationally through math, science, or logic training, alongside extensive reading and maintaining curiosity.
Doing so provides more tools for investors to use, what I call a multi-faceted mental model. multifaceted FINQbot mindset. I also have my own methods for developing these skills, such as understanding externalities (grasping spillover effects from economic activities).