The power of compound interest

[ysette9]

This isn’t quite the right sub forum since it isn’t anything badass we have done, but close enough. I wanted a place to marvel at the awesome power of compound interest and the stock market and I certainly can’t do this in real life.

I checked out end-of-year numbers and compared against last year earlier today. We have enjoyed $300k worth of investment gains as part of our net worth growth in 2019. Mind boggling, right?

I took this engineering finance class back in undergrad and i still remember the lecture on compound interest and seeing the exponential curves. In that moment it was like the light shone and the angels sang and I couldn’t wait to get a job and start saving so I could start out on my own exponential curve. My savings curve was frustratingly linear for many years but I think I have finally got it to take the right shape. :)

[BECABECA]

I know the feeling, my gains this year were more than my salary ever was!

It’s also good to note the power in the opposite direction that management fees can have on dragging against compounding. I am currently helping family move their inherited IRAs out from under a “family friend” financial manager. The management fee was over 3%! Needless to say, those accounts didn’t compound like mine have.

[Bloop Bloop]

Interest is not the only thing that compounds. All advantages compound. I'd say arguably the most important of those is reading skills/vocabulary (a child who is a fast reader at age 4 or 5 will gain so many advantages over the rest of his or her career) and also reputation at work (if you start your career well you can climb the ladder much more quickly and also control the playing field for others). Long story short, remember that everything, good or bad, compounds.

[Dicey]

This is why I'm so persistent on the DPOYM thread, which makes me unpopular to some. OMG, the power of compound interest is un-fucking-believable! It blows my mind that our money earns more than we do without lifting a finger! If my younger self had gotten that through her thick skull earlier, I could have probably shaved years and years off my working life.

[ysette9]

I know the feeling, my gains this year were more than my salary ever was!

It’s also good to note the power in the opposite direction that management fees can have on dragging against compounding. I am currently helping family move their inherited IRAs out from under a “family friend” financial manager. The management fee was over 3%! Needless to say, those accounts didn’t compound like mine have.

Holy highway robbery, Batman!

[ysette9]

This is why I'm so persistent on the DPOYM thread, which makes me unpopular to some. OMG, the power of compound interest is un-fucking-believable! It blows my mind that our money earns more than we do without lifting a finger! If my younger self had gotten that through her thick skull earlier, I could have probably shaved years and years off my working life.

I acknowledge that we have had a pretty amazing run on the stock market almost my entire investing career, which makes it much easier to admire this power. I fully expect it will go the other way sometime soon after we stop working. ;-) I can remember I think it was 2007 when the market downturn ate all of the 401k contributions i had made that year. I looked at my statement, saw the Jan and Dec balances were the same, was sad for a moment, and then decide to ignore it. If only I had had more disposable income at that time to invest.

[henramdrea]

Yep! There's a good reason old Warren Buffett called compound interest "the eighth wonder of the world".  I'm constantly amazed by it, even though it works the same every time!

[Brother Esau]

The DW and I are more frequently commenting on how the stash is earning more on a weekly & yearly basis than our jobs. Good times!

[ysette9]

The DW and I are more frequently commenting on how the stash is earning more on a weekly & yearly basis than our jobs. Good times!

That means you are close to pulling the plug, right?

[Brother Esau]

The DW and I are more frequently commenting on how the stash is earning more on a weekly & yearly basis than our jobs. Good times!

That means you are close to pulling the plug, right?

Sort of. DW has been working part time at something she enjoys for awhile now and I switched to a chill municipal job that comes with great benefits. I think of it as a Pre-Retirement. We are definitely FI and RE is certainly near.

[Simpli-Fi]

Glad to see I'm not the only one who was shocked/amazed at 2019 market gains; after all the experts told us to be happy and expect single digit returns.  Hell, simple VTSAX was 30% up...I actually intentionally bought (rebalanced) bonds as I finally feel closer to retirement; 10% up from 4%.

Target retirement = after next recession

EDIT: Why do we refer to this as "interest"?  Compounding dividends with market growth doesn't roll off the tongue.

[Chris @ Saturday Financial]

Glad to see I'm not the only one who was shocked/amazed at 2019 market gains; after all the experts told us to be happy and expect single digit returns.  Hell, simple VTSAX was 30% up...I actually intentionally bought (rebalanced) bonds as I finally feel closer to retirement; 10% up from 4%.

Target retirement = after next recession

EDIT: Why do we refer to this as "interest"?  Compounding dividends with market growth doesn't roll off the tongue.

"Compound investment returns" is a good combination of succinct and accurate. Or perhaps "compound returns" if you want to lean a little more toward succinct.

[Kazyan]

Debbie downer: I'd like to marvel at compound interest and all, but the base of the exponential function is small and take a very long time to take off. At an average of 5% a year after inflation, a contribution takes 14 years--basically an entire stage of your lifespan--to double.

[Dicey]

Debbie downer: I'd like to marvel at compound interest and all, but the base of the exponential function is small and take a very long time to take off. At an average of 5% a year after inflation, a contribution takes 14 years--basically an entire stage of your lifespan--to double.

Why is this not a reason to get started asap? Where did you come up with 5%? Use real numbers for a more accurate assessment.

[ysette9]

Debbie downer: I'd like to marvel at compound interest and all, but the base of the exponential function is small and take a very long time to take off. At an average of 5% a year after inflation, a contribution takes 14 years--basically an entire stage of your lifespan--to double.

Why is this not a reason to get started asap? Where did you come up with 5%? Use real numbers for a more accurate assessment.

No kidding. I think DOUBLING your money is pretty damn cool! Not to mention, in those 14 years you will be continuously adding more savings to your investment pile, so it will grow that much more. Heck, 16 years of working and we are done, thanks to savings and the magic of stock market returns.
I’m not complaining about that.

[Kazyan]

Oh, the shockingly simple math behind early retirement is certainly correct, and I'm using it to hopefully FIRE at 36; it just feels quite a bit less magical when the operative time frame is a significant chunk of one's lifespan and is dominated by contributions instead of compounding, basically.

[Bloop Bloop]

Debbie downer: I'd like to marvel at compound interest and all, but the base of the exponential function is small and take a very long time to take off. At an average of 5% a year after inflation, a contribution takes 14 years--basically an entire stage of your lifespan--to double.

Why is this not a reason to get started asap? Where did you come up with 5%? Use real numbers for a more accurate assessment.

What's wrong with 5% per year after inflation?

Since I graduated in 2010, the Australian share market has gone up by only 49%. Which is about 4.1% per year. Or about 2% per year after inflation. In the same period the property market has gone up only 69%, or 5.5% per year, or low 3's after inflation.

Keep in mind also that any capital gains are taxed at 1/2 the marginal rate (47.5%) in my country. So even if my shares or property went up 7% per year, the benefit accruing to me when I sell would be about 5.5% per year.

I know that Americans have made a killing since 2008, but that hasn't been replicated elsewhere, and I think it is unlikely it will continue for the next 10 years.

[ysette9]

Oh, the shockingly simple math behind early retirement is certainly correct, and I'm using it to hopefully FIRE at 36; it just feels quite a bit less magical when the operative time frame is a significant chunk of one's lifespan and is dominated by contributions instead of compounding, basically.

Well, compounding works its magic over time, by its very nature. So you have two choices: save a lot and do a lot of the heavy lifting yourself, and retire early, or save a little bit over a long time period and let compounding do more work. Which do you prefer?

Even over a 15-year career there is good time for compounding to work. The beauty is that once you have a good chunk of cash working for you, even a 3% increase translates to a lot of actual dollars. Our down payment for this house came entirely from market gains from what we had invested at Vanguard. That isn’t too shabby.

Most importantly, market gains will be the secret sauce that will keep us financially independent after reaching our number.