Those who understand interest, receive it. Those who don’t, pay it. As investors, we believe this and we strive to go one step further. We seek to get paid interest on our interest. We call this compounding interest.
Albert Einstein called compounding interest “the most powerful force in the universe” and “the eighth wonder of the world.”
It is this mathematical force that has driven the Dow Jones Index to new highs and to over 15,000 this year.
Like everything in life there is a catch. It takes time to achieve compounding interest and it involves uncertainty.
Time
One of the first questions we ask investors is “What is your time horizon?” In other words, “When do you plan to spend this money?”
This is critical because it may take some time to realize the benefits of compounding interest. On June 30, 1993 the S&P 500 was at 450. Fast forward one year and the return was negative 1 percent. Move forward ten years and the total return was 116 percent. Twenty years later, in 2013, the total return was 256 percent!
It pays to be patient with investments. It pays to keep a long-term perspective.
Uncertainty
The stock and bond markets do not travel in straight lines. There are days when they rise and there are days when they fall. If we don’t accept the uncertainty, then why would we expect to receive a reward.
As investors, we must accept some risk and we believe that over long periods of time, these markets will reward us.
In the last 50 years, the S&P 500 has gained 2,215 percent. Despite this fact, the market was positive only 42 percent of the months. That sounds like a frightening outcome, but the average return for all months was still a positive 0.6 percent.
The good news is that the longer the time period, the more likely an investor is to achieve growth. Positive returns occurred in 53 percent of the years, in 60 percent of 5-year periods, in 80 percent of 10-year periods, and in 100 percent of 20-year periods.
What can we expect in the future?
I believe there is still room for growth. I believe potential for improvement in technology, housing, energy, and employment could fuel this growth.
I expect that the further we look in the future, the more likely we are going to see opportunities to compound returns.
I believe the Dow Jones Index, which currently is flirting with the 15,000 level, is likely to reach 30,000. In my mind it is not a matter of if, but when.
What does all this mean? As we like to say at SFS, “Now is always the best time to invest.”
