I’ve been interested in studying the most successful investors in history since my early 20s. One striking thing is how many of these people attribute their success to understanding simple investing concepts like compound interest. That said, simple doesn’t always translate into easy.
Recently I was listening to a discussion between the podcaster Tim Ferriss and hedge fund legend Edward Thorp. The podcaster asked Thorp a question about financial literacy. Part of Thorp’s response included the “rule of 72” and the power of doubling over time. He emphasized his point by explaining how much an investment grows if compounded by 10% for 100-years. The factor was so big I giggled to myself in disbelief.
Intrigued, I sat down with my financial calculator and punched in a few figures to gain some further context. I was curious what $10,000 would be worth if compounded at 10% over a century. Astonishingly the figure is over $137 MILLION (let that sink in).
Coincidentally, if you research the long-term average return of US stock indexes, like the S&P500, the number in most rolling 30+ year periods is around 10% (including dividends).
So, getting rich is easy if you just have enough time, right? Not so fast. Simple concepts don’t directly translate to “easily executed” in the real world.
This brings me to another investing sage, the late Charlie Munger, who recognized that human psychology often gets in the way of the outsize results compounding can create. Munger famously quipped that, “The #1 rule of compounding is to never interrupt it unnecessarily.”
His point was, if you have a compounding machine, don’t screw it up by getting scared because some guy on TV said the market is going to crash, an election is coming, or some new technology looks disruptive. And don’t try being too clever by thinking you can dance in-and-out of the market. If you own a good asset that is appreciating over time, the worst thing you can do is sell.
Having worked with hundreds of people over my career, I’d add one thing, don’t own a portfolio with more market risk than you can stomach. Compounding just doesn’t work if you bail out.
The key for retirees is implementing an income strategy that works even when the periodic market storm hits. As I tell clients regularly, expect a big market downturn every 5-years or so. In my experience, most people can hang in there (with their portfolio) so long as their monthly income isn’t materially affected. But this requires a thoughtful plan.
The power of compounding is remarkable. I still shake my head thinking about $10k growing to $137 million. Understanding these foundational concepts is important. But Munger’s point about not “interrupting it” reflects the difficulty of realizing good results in practice. The stock market always has and always will be volatile. Therefore, having a plan that allows you to stay on the compounding train is key.
Important Disclosure
Norris Lake Financial Planning is a SEC registered investment advisor able to conduct advisory business in states where it is registered, exempt or excluded from registration. All contents contained herein should not be construed as an offer or solicitation for investment advice or for the offer or sale of any security, insurance or other investment product. Data contained here is obtained from believed reliable sources, however, cannot be guaranteed. Investments contain a risk of loss. Please consult a qualified legal, tax or accounting professional before implementing any investment or strategy discussed.