The power of compounding is the #1 lesson I want to teach in personal finance. I believe it has the largest impact and the power of compounding affects all areas of life, not just investments. A few quick questions to start:
Questions
- When did Apple become a publicly-traded company?
- What has been the total return (excluding dividends) if you invested in Apple on day 1?
- What has been the average annual return of Apple?
Answers
Can you come up with at least a couple of rough estimates for these questions?
- Apple first sold shares to the public on Dec. 12, 1980. They have been a publicly-traded company for over 40 years now.
- Your total return would be 97,892%, if you exclude dividends. If you include dividends, it would be even greater. To put that into perspective, a $100 investment would turn into $97,892. If you put in $1,000, it would be worth $978,920. I think we can all see the relationship. Hats off to the early investors who have held all this time.
- This is the part that amazes me the most. Apple, which has been one of the greatest publicly traded companies in history, has an annualized return of 18.76%. Can you believe that? You would have thought that in order to get to a near 100,000% return over 40 years, they must have grown on average more than 50% a year.
I’m sure I’m the one who was most excited by figuring out that Apple has an average return of 18.76% out of anyone reading this, but it’s a reminder of how impactful compounding can be. In terms of return in the stock market, you would be a first-ballot hall of famer within the investing community. I know it might not seem that hard to do because 18% doesn’t seem that large, but the greatest investors of all time barely return over 20% on average for long periods of time.
So what did I learn from figuring out that Apple “only returned 18%” a year since going public? It reassured me that the longer the time horizon you have, the more likely you’ll have success with your investments. For example, a $10,000 investment that gains 10% a year (slightly above market average) for 50 years would be worth $1.1 million! No additional money is being added. How crazy is that?!
Time exaggerates your return. You have two different investments – Investment A returns 8% a year and Investment B that returns 11% a year. With an initial investment of $10,000 and one year later, Investment A would be worth $10,800 and Investment B would be $11,100. Not that much of a difference, right? Now, what’s the difference if we looked at them 50 years into the future. Investment A would be worth $469,016.13 and Investment B would be worth $1,845,648.27. That’s a noticeable difference in terms of wealth that’s accessible to your everyday 75-year-old. What about if you added an additional $1,200 each year? Investment A would be worth $1,157,540.31 and Investment B would be worth $3,848,173.65. This could result in a step-up in your retirement lifestyle.
These couple of percentages result in potential noticeable lifestyle changes for some. The difference of having $500k compared to several million in your retirement account would mean something to most. Maybe it results in a couple of more trips or being able to help support your family and community slightly more. For me, it’s not worth worrying about returning 8% vs 9%. I know that I’ve got a plan and everything will shake out with time.
I’m trying to see how the power of time and compounding would affect other aspects of my life. If I averaged 33% more workouts a week (working out 4 days a week instead of 3), then I would have worked out 5,000 times over a 25 year period instead of 3,750. What about reading? What about if I read for 15 minutes every day compared to 15 minutes every other day? Reading every day would mean that I’ve read for 190 days of my life compared to 95 days over a 50 year period. Put in your favorite new years resolution type of activity and see how it can be affected over a long period of time. We’ve got a lot of life to live, so let’s make sure we’re doing things that are worth our time and we enjoy!
Peace and love.