The first rule of compounding: Never interrupt it unnecessarily.
Charlie Munger
In Indian folklore, a minister and wiseman called Sessa, apparently invented chess for his King, and in return asked for payment in grains of wheat: one grain on the first square, two on the second and doubling each square thereafter. The King laughed at him, for asking for such a small prize, obviously not realising that on the 64th square it would be 263 (i.e. two to the power of 63, or 9,223,372,036,854,780,000) grains of wheat! It was Sessa who got the last laugh.
Figure 1: Doubling grains of wheat on each square of a chessboard
Source: Albion Strategic Consulting
It has been estimated that this represents around 200 times the global wheat harvest today! Obviously, investing is unlikely to double your money every year, except in very extreme cases, usually being a recovery after a very large market fall. We have to content ourselves with much lower mid to low single-digit returns on average after inflation when we invest. Yet when investing, small returns – and differences in returns – can grow into large differences in the value of your wealth. On the upside, these might be positive returns from an investment portfolio. On the downside, these may be from costs you incur or from inflation.
There is a nifty rule called the ‘Rule of 72’ that you can use to see how quickly you will double your money based on the returns you achieve, or alternatively how quickly the value of money will be halved by inflation. All you need to do is divide 72 by the rate of return, or inflation. So, a return of 3% will double your money in 24 years (72/3=24).
Figure 2: The Rule of 72 – time to double your spending power using after-inflation returns
Source: Albion Strategic Consulting
Having the patience and fortitude to remain invested in a sound solution enables investors to benefit from the immense benefits compounding can bring.
Risk Warnings
This article is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author and does not represent a recommendation of any particular security, strategy, or investment product. Reference to specific products is made only to help make educational points. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.
Data series used: global equities – Vanguard Global Stock Index $ Acc in GBP; global bonds – Dimensional Global Short Dated Bd Acc in GBP