Compounding: The Boring Key To Huge Long-Term Investing Returns

There’s no shortage of stock market millionaires who achieved wealth beyond their wildest dreams by making smart investing decisions. However, the vast majority of these investing success stories didn’t happen overnight. The stock market has an incredible track record of creating wealth, but the most powerful one-two punch on Wall Street is compounding and time.

Big Start To 2019

Ritholtz Wealth Management portfolio manager Ben Carlson recently discussed just how powerful compounding can be.

Through the first four months of the year, the S&P 500 was up roughly 18 percent overall. That huge gain represented the best start to any year for U.S. stocks since 1987 and just the fourth time since the end of World War II the S&P 500 has gained at least 15 percent in the first four months of any year.

However, if you’re wondering why 2019 hasn’t seemed like the hottest stock market in more than three decades, it’s because there were very few really big days for stocks through the end of April. In fact, the average daily gain for the SPDR S&P 500 ETF Trust SPY this year through the end of April was less than 0.2 percent.

“And this is generally how compounding works over time. Small gains can eventually add up into big gains if you let them,” Carlson wrote.

For example, Carlson said a 6 percent return on a $100,000 investment will return $6,000 in the first year. However, if that return is compounded over 30 years, that original $100,000 investment will grow to nearly $600,000.

Snowballing Returns

In the first few years of saving and investing, the saving part of the equation will likely be responsible for the lion’s share of the portfolio growth. However, the longer investment gains are allowed to compound, the higher the percentage of the overall balance will come from investment returns.

“Compound interest is extremely back-loaded, which is something that’s hard to see unless you actually plot it out on a spreadsheet,” Carlson said.

Unfortunately, compounding works so slowly that it is hard to recognize or appreciate on a daily or weekly basis. However, just because responsible long-term investment decisions aren’t always exciting doesn’t mean they should be underestimated.

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