Imagine what it would be like to have invested $100 in the stock market in 1928 and held on to it until today. What’s the growth of $100 invested in 1928?
$100 invested in the stock market in 1928 would be worth over $450,000 today. Not bad!
The growth of the different asset classes is shown in the table below:
Even though the investment was made at a market top just before The Great Depression, you would have achieved great returns. 100 Invested equals 450,000 today, which is over 9% annual returns (dividends reinvested):
(Source: Kenneth French database.)
That said, many don’t want to invest and keep the money in stocks until you die. You’ll have no fun, except for the great feeling of seeing it grow and giving it away to your children or whatever cause you are supporting.
What would happen if you only held your investment until 1974 and withdrew your money in the middle of a bear market?
Ouch, not so good:
Why is this? It’s because of much less time invested.
- Compounding takes time – it snowballs. It starts small, but it might end big (see more below).
- Over long time horizons, bear markets don’t matter much.
- Over short time periods, bear markets matter. Pensioners should take notice. The sequence risk matters for short periods but becomes less significant as time goes by.
What is the snowball effect of compounding?
The snowball effect in compounding is when your earnings start earning earnings, and so on. This can lead to exponential growth over time.
This is because you are earning interest on your interest, as well as on your original investment. This is what the famous investor Howard Marks calls “the interest of the interest”.
The snowball effect is one of the most powerful forces in finance. It is why it is so important to start saving and investing early. Even if you can only invest a small amount each month, the power of compounding will help your money grow over time. The only biography about Warren Buffett endorsed by the man himself is called Snowball. This is no coincidence.