There are, broadly, two ways people get rich: compound interest, or all at once. Compounding is easy to understand: someone with an above-average job and a below-average-cost lifestyle scrapes together their excess cash, invests it prudently in either a business they own or in pieces of other people's business, and, given enough time, comes out way ahead. An extreme example of this would be someone like Herbie Wertheim, the billionaire optometrist, who bought into the Apple and Microsoft IPOs among others.

Wertheimer, to be clear, is not an example of some perfectly average guy who followed some simple rules, saved diligently, and ended up being worth billions of dollars. He's actually a good example of how nice it is to participate in a market while its efficiency is improving—he had a difficult childhood but ended up being identified by himself and others as smart when he scored well on a standardized test in the military. His early gigs included working at NASA, and he founded a company that eventually produced $10m or so in annual profits. But his $5bn net worth requires a lot of capital appreciation on top of that $10m/year. So in a sense he's really a cautionary tale about how much money you might leave on the table if you don't charge 2 and 20 when it's possible.

And then there's the kind of step-function change in net worth, where someone who raises their Series A suddenly becomes a decamillionaire, but still has roommates and drives a used car. Those net worth spikes are, technically, their own form of compound interest, but that's more of an artifact—the funding rounds of great startups are retrospectively undervalued, and the trend in the last decade of higher early-stage valuations is mostly correcting a market inefficiency.

For example, a biotech company that raises its first round based on a 1% probability of successfully developing a drug, then raises at implied odds of 5%, then 20%, then 50%, before getting acquired at a price that reflects the 100% odds of an approval that's already happened, is in one sense an instance of compounding, but in another it's an example of someone who, due to inefficient markets, had to sell some of their business at a 99%, 95%, 80%, and 50% discount to fair value.

To look at concrete examples of this it's instructive to look back at the Microsoft IPO prospectus and ask how such a company would be valued today. Part of the answer is that "such a company" doesn't exist anymore: 33% growth at 34% operating margins as the market leader in an industry going through extreme secular growth would make modern VCs apoplectic—today they’d want the company's sales and marketing as a percentage of revenue to be something like 150% (to accelerate growth even more), not the 29% that Microsoft ran with. Teleport the modern venture ecosystem back to the 1970s, and Microsoft would raise more, grow faster, dilute Gates and Ballmer more substantially, but also either a) end up being an even bigger company counterfactually than it is today, or b) reach the point where it's saturated its market to the point that it needs to return some cash to shareholders much earlier. In retrospect, Microsoft got it exactly right, reserving its equity for founders and employees until as late as possible, but in this counterfactual, if they'd been too resistant to raising funds, someone else would have outraised them and potentially run away with the talent, the strategic acquisitions, the economically-equivalent-to-exclusive partnerships, and, in the end, the entire market. Microsoft compounded for a long time partly out of choice, and partly because of an inefficient hiring market and the rest of the world's inability to recognize how important PCs would be. In a more competitive world, they would have grown faster, by necessity.

Someone like John Paulson also illustrates this model of compounding and step-function growth as being more closely tied than people think. Paulson's fame comes from one amazing trade, betting against subprime. But the reason he was in a position to do that was that he'd spent decades grinding, successfully, as a merger arbitrageur. In almost any context, Paulson-circa-2006 was an incredibly successful person; he was an owner-operator of a hedge fund that ran half a billion dollars. But he jumped a few spots on the Forbes 400, and in terms of public recognition, after one big win.

The hedge fund world supplies other examples of this: Ken Griffin actually spent very little of his career managing money (in the sense of personally running a portfolio and making trades); he started doing that with personal money in high school, with friends-and-family funds in college, and then launched a hedge fund in 1990. But within a few years, he'd stepped back from running the fund's convertible arbitrage strategy in order to focus more on building a platform that could effectively run just about any strategy. (Or really two platforms, Citadel-the-hedge-fund for anything that could deploy significant amounts of capital, and Citadel Securities for capacity- rather than capital-constrained strategies like market-making.)

In a sense, the actual trading part of his career was like Herbert Wertheimer's stint at NASA: an instructive gig from early adulthood that would provide the raw material for later successes. Citadel's valuable insight was that money management could be systematized, and in particular that the back- and middle-office functions—getting access to borrowed money and borrowed securities on favorable terms, monitoring risk across the entire fund as well as individual strategies, being first to bid on a portfolio when a competitor is blowing up and scheduling the first interview with their talent if the blowup already happened—could generalize across every strategy and make all of them better. And the natural force of economic gravity is that if one employer can produce $10m a year in profits from a given employee, and someone else can push that number up to $11m, the latter is the high bidder for their skills.

If compounding is often an artifact of the slow deployment of a key insight, does that mean it doesn't matter? Hardly. First, most people won't have such an insight, or won't recognize it. Second, decades of above-average net worth compounding are the reward for taking a big idea seriously, continuously refining it, and implementing it in the real world.

Microsoft's early marketing was prophetic; they were saying "we set the standard" long before even their bugs became de facto standards. Bill Gates was certainly not the only person to recognize how big a deal computers would be, or even the only person to devote a substantial effort to making that happen and taking advantage of the results. But that process spent very little time in the land of big insights and leaps of faith, and a lot more time in the world of cutting feature lists down to size, fixing tricky technical limitations, cutting deals, and the like. Even if the concept of a "billion-dollar idea" exists in some Platonic sense, the shadows that they project on the real world look a whole lot like a gradual, continuous process that was only inevitable in retrospect.

Read More in The Diff

The Diff has covered the interplay between big ideas and slow compounding in many times and contexts. For example:

• The Man Whose Bank of England Broke ($) examines the other side of a famous trade, George Soros' coup shorting the British pound in 1992.

• We have a series on "compounders" that stopped compounding, like this case study of Coca-Cola ($).

• This is adjacent to the idea of spiky generalists and meta generalists.

• And the capital intensity of a company, a key input into the compound-vs-step-function tradeoff, is really a trait of cycles rather than industries.

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