There’s no subject personal finance bloggers love gushing over more than compound interest. Conjure up a conveniently “assumed” rate of return, give it a few decades or a few centuries, and presto, you’re worth more than Warren Buffett.
The thing about compound interest, though, is that it doesn’t work over long time periods, it works over many time periods. I was riffing on Twitter the other day about the “sideways” stock market that had nonetheless doubled in the last 5 years, and suddenly wondered: what would a steadily compounding investment portfolio look like in real time?
The answer, which is obvious after a few moments of reflection, is it would look completely and utterly boring.
Imagine a diversified portfolio of stocks and bonds that you expect to compound annually at 6% APY for 30 years, which I treat as the maximum realistic return to expect from such a portfolio. This would result, in 30 years, in a portfolio that’s about 5.7 times as large as your starting investment. The magic of compound interest, etc.
Then imagine that rather than the actual rollercoaster of the stock and bond markets, the value of the portfolio rose steadily each and every day for the entire 30 years. What would that look like in real time?
- If you checked the value of your portfolio each of the 252 days the US markets are open each year, you would see it rise by 0.02% per day.
- If you checked the value of your portfolio each of the 52 weeks in the year, you would see it rise by 0.11% per week.
- If you checked the value of your portfolio each of the 12 months in the year, you would see it rise by 0.49% per month.
- If you checked the value of your portfolio once a year for 30 years, you would see it rise by 6% per year.
- If you checked the value of your portfolio each of the decades in 30 years, you would see it rise by 79% per decade.
- And if you check it just once at the end of 30 years, you’d see it rise by 570%.
Don’t peek, but if you do peek, know how to interpret what you’re peeking at
Jack Bogle deserves — and receives — all the credit in the world for making low-cost, tax-efficient indexed investment vehicles available to retail investors.
But you’ve also got to pay respect to Bogle’s investment aphorisms, my favorite of which is “don’t peek.” When your brokerage statements arrive, Bogle wants you to throw them in the recycling, unread.
Now, you’re probably not going to do that. I certainly don’t do that (I don’t even know any cardiologists). I check my account balances every day, like some kind of digital Scrooge McDuck.
But if you open up your Vanguard account at the end of each day to see “how you did” and your balance has increased by 0.02%, it hasn’t “moved sideways,” it isn’t “flat,” and it isn’t “uneventful.”
It’s compounding at 6% APY — let it!