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Business News/ Money / Personal Finance/  What rabbits tell you about power of compounding

What rabbits tell you about power of compounding

The introduction of 24 rabbits to Australia in 1859 led to a rapid increase in their population due to lack of predators. This demonstrates the power of compounding, which takes time to show significant results. This lesson applies to investing, where compounding can yield significant returns over the long term.

Most investors do not benefit from this power of compounding. (iStockphoto)Premium
Most investors do not benefit from this power of compounding. (iStockphoto)

Have you ever heard of Thomas Austin? Austin was an English settler in Australia, who In 1859, imported 24 rabbits from England, and released them in Australia. As Bill Bryson writes in Down Under: Travels in a Sunburned Country: “Thomas Austin, a landowner in Winchelsea, Victoria… released [24 rabbits] into the bush for sport. It is hardly a novel observation that rabbits breed with a certain keenness. Within a couple of years they had entirely overrun Austin’s property and were spreading into neighbouring districts."

The trouble was that Australia had never seen anything like the rabbit before. As Bryson writes: “Fifty million years of isolation had left Australia without a single predator or parasite able even to recognize rabbits, much less dine off them, and so they proliferated amazingly."

The number of rabbits increased at a very high rate of 35% per year, points out Pulak Prasad in What I Learned About Investing from Darwin. Now 24 rabbits increasing at 35% per year doesn’t really sound much? Does it? But the numbers just became astonishing as time went by. Five years down the line there were just 108 rabbits, which was clearly not a problem. Twenty years down, there were just 9,700 rabbits. And 35 years down the line, there were nearly 900,000 rabbits. And after this the numbers just went off the charts. There were 17.5 million rabbits 45 years after 1859. At the end of the 66th year, there were 9.59 billion rabbits or close to 10 billion rabbits.

As Prasad puts it, these rabbits “wreaked havoc on the flora and fauna of the continent". In fact, as Bryson puts it: “Rabbits [devoured] every bit of it—leaves, flowers, bark, stems—until none was to be found. The rabbits ate so much of everything that sheep and other livestock were forced to extend both their range and their diet, punishing yet wider expanses."

This example of the proliferation of rabbits in Australia shows the real power of compounding along with why most people don’t get it. The rabbits—even though they reproduced at a rapid rate—did not become a problem for a long time. As Prasad writes: “Nothing happened for a very long time! [emphasis in the original]… Even after forty-five years, there were fewer than two rabbits per kilometre. So Australians ignored the rabbit problem for many decades." Now, the “bigger mystery of compounding is not that it leads to large numbers but that it doesn’t do so for a long time".

And this has a lesson in investing: The real power of compounding comes into the picture only a few decades down the line, like the number of rabbits jumped from 900,000 in the 35th year to 17.5 million in the 45th. Now how does this stack up when it comes to a real life investing example? Let’s take the case of the Public Provident Fund (PPF), which has an initial lifespan of around 15 years. Let’s say you invest 1.5 lakh every year into it and the rate of interest paid on it amounts to 7.1% per year, as is the case currently.

At the end of 15 years, you would have ended up with around 41 lakh. Now, this is a lot of money given that no tax needs to be paid on it. But the real fun only starts after 15 years. Let’s say you are 45 years old and still have 15 years to go before you retire. The PPF account can be extended for five years at a time, with or without contribution. Let’s say you decide to continue contributing and extend the account every five years. At the end of the twentieth year, the investment would be worth 67 lakh. By the 25th year it would be worth 1.03 crore. By the 30th year, when you are ready to retire at 60, it would be worth 1.55 crore. Remember, the PPF investment was 41 lakh at the age of 45.

So, as Prasad puts it, “compounding does not lead to significant numbers for a very long time". Given this, it makes sense to keep extending the PPF account. Clearly, most investors do not benefit from this power of compounding. As Prasad puts it: “What is needed to become a successful investor is not intellect, a commodity, but patience, which is not."

Vivek Kaul is the author of Bad Money.

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Published: 02 Jul 2023, 10:14 PM IST
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