Henry: So, we are going to talk about compounding. And not just compound interest, but also the concept of compounding. There’s a positive and negative. So behaviorally, Linda, you and I were discussing before the lights went on, preventing people from making mistakes, and how does that impact compounding.
Linda: Big mistakes compound the disaster over the years.
Henry: What would be an example of that kind of mistake?
Linda: Sinking a large amount of your money into what you believe to be a sure thing, and it turns out to be a disaster, and it decimates your retirement plan.
Henry: Another way to look at it is also the idea that compounding works as long as you don’t interrupt it. People who decided to bail out because they didn’t get the outcome that they wanted in an election, or during last March’s market turndown…we spoke with people who were given advice, and it sounds ludicrous now, but it sounded perfectly acceptable to some people, to take the bulk of their retirement portfolio, that was supposed to support them for 20-30 years, and pull it out of the ownership of the best companies in the world, equities, and put it into a 3% account at some insurance company. And how 3% works in a world filled with inflation and other challenges is beyond us.
Linda: But it feels safe.
Henry: In the moment. It’s climbing the mountain, and you’re out there in the fog, and you think you’ve gotten to the top, and all you’ve gotten to is a little rise, and the summit is way beyond you. That sort of false sense of security. In fact, people blew up their portfolios because they’ve interrupted compounding. And now they want to come back in, with prices 50%-60%-70% higher than they were then, you cannot undue that level of error. So compounding is super important.
Linda: And the negative side of compounding is if you have credit card debt, or any high interest debt. That’s the negative side of compounding.
Henry: The Dow when we were born back in the 1950’s was about 400, and today we have that index trading at over 34,000. Same with the S&P, although it’s not entirely clear there was an S&P 500 when we were born…so you have to use some sort of composite. You look at that, and you go “My God this thing has gone from 400 to 34,000, that’s remarkable”…but that’s 10%/year.
Linda: But at each moment of downturn, cash has always felt like the saftest option. Always.
Henry: So, compounding is there, it works to our benefit, it works within businesses. Businesses compound: they buy a new division, or they make an acquisition. Google seemed to overpay years ago for YouTube. Facebook seemed to overpay for Instagram. Boy, both of those decisions look pretty brilliant right now financially. When we look at this, our job is to participate in the compounding on the macro and the micro level, and not get in the way with transitory fears and anxieties.