Short-Term Speculation Erodes the Power of Compounding

According the experts at Bloomberg Intelligence, the three biggest firms that execute individual investors’ orders traded a combined 69.4 billion shares over the counter in June 2020, more than triple the level from November 2019. This trend encourages me to remind those who follow this blog of the impact compounding plays on the accumulation – or diminution – of wealth.

According to the experts at Bloomberg Intelligence, the three biggest firms that execute individual investors’ orders traded a combined 69.4 billion shares over the counter in June 2020, more than triple the level from November 2019. This trend encourages me to remind those who follow this blog of the impact compounding plays on the accumulation – or diminution – of wealth.

Compounding Core Values

Compounding is at the very core of developing an optimal long-term saving and investment program… and its value is THE primary reason why my target audiences are the younger generations of savers. Simply put, they have more time to benefit from compounding. Too often, unfortunately, they display the least amount of patience. And why does that matter? According to the 90-year-old Sage of Omaha, Warren Buffett:

“Building wealth depends not only on how much your money grows, but how long it grows.”

BTW: The Sage’s wealth is estimated to be over $80 billion, 90% of which he acquired after age 65.

In a recent WSJ interview by Jason Zweig, Buffett mentioned what he termed his Methuselah Technique:

“Investing wisely is important, but investing wisely for a long time matters even more.”

Astounding Example

Zweig mentioned in the WSJ article that most folks routinely underestimate the power of compounding (an observation with which I absolutely concur)… and that such errors worsen over longer time horizons and at higher rates of return. He offered an example inspired by Buffett. It’s a theoretical exercise, but what an attention grabber! If the Dow Jones Industrial Average (DJIA)… about 29,100 yesterday… compounded at slightly under 1.6% annually, what would it be on December 31, 2099? The answer: 100,000. What if it earned 4.6% annually? The December 31, 2099 value would be 1,000,000. And what if it earned 7.7% annually (below its 8.4% average over the past 30 years)? 10,000,000 by December 31, 2099.

In a nutshell, that’s the potential of The Amazing Power Of Compounding. Crazy numbers… not so much. In August 1940, the DJIA was roughly 130. On September 2, 2020, it closed at 29,100. By the way, none of the rates in the Zweig/Buffett example include the reinvestment of dividends.

Patience is Vital

As I’ve often mentioned in my blog posts, even while experiencing low to moderate rates of return on investment portfolios, lengthy periods of steady growth can morph small sums of money into large amounts. But it takes a truckload of patience and the steady accumulation of a low-cost, highly-diversified, quality portfolio to take advantage of compounding. For this reason, it’s troubling to see more and more speculation by folks – particularly younger investors – buy and hold stocks for noticeably short periods of time… so very destructive to the essence of compounding.

Buffett’s Folly

Buffett revealed an interesting inclination (that also afflicts yours truly) in his interview with Zweig… a habit of the afflicted that causes them to weigh a “current” expenditure against what they might be able to buy with the same money compounded for decades into the future. An example used was the initial $31,500 cost of Buffett’s Omaha home. He called the “then troubling” 1958 acquisition "Buffett’s Folly" in The Snowball, written by Alice Schroeder. In his mind, the cost of the home was $1 million after compounding its initial cost into the future. He wasn’t far off. The home is now worth close to $700,000 and the $31,500 he spent on it in 1958 is equivalent to about $250,000 in today’s dollars.

Stop Starting Over

To my young investor friends, the more often you trade holdings in your investment portfolio, the more you disrupt compounding. After each disruption, you essentially start the process all over again. In short, avoid excessive trading. Follow those PDQ Principles of investing. Buy low-cost, highly-diversified, good quality investments, and then exercise the patience of Job with your portfolio. You’ll be glad you did.