If you stand and watch runners at the 25-mile mark of most marathons, it may seem like you’re watching the walk of the living dead. Many participants are walking and/or limping and seem to be talking to themselves. They move with a bit of a shuffle. Their feet don’t leave the ground in any measurable way. They’re exhausted and wear an uncomfortable (almost disoriented) look on their faces. Perhaps from exhaustion caused by the 25 miles of pounding or even from the discomfort caused by chafing, which, as a friend once told me, “There is no good kind of chafing . . . .”
Some of these weekend warriors are simply having a bad day. They’ve trained sufficiently but, for some reason, things simply aren’t working out for them.
As Hal Hidgon (a famous runner - obviously) once said…
"The difference between the mile and the marathon is the difference between burning your fingers with a match and being slowly roasted over hot coals."
Sufficiently trained runners having a tough time on marathon day are not the inspiration for this analogy. It’s the ones who haven’t trained. They enter the marathon but don’t prepare for such a humbling distance. So, on race day they pay a mighty price. Oh, they read all the motivational signs all right like "Pain is temporary, pride is forever." Blah, blah, blah; but, in the end the pain wins and their bodies lose.
Their feet begin to fail. Blisters, the (aforementioned) chafing and a plethora of other painful problems emerge. Finding a porta-potty is the least of their problems. Yes, these runners are beating everyone sitting at home on their couch but it’s not going well. The mile markers are getting further and further apart. (Is somebody moving them?) The worst part: Nobody is going to like their Facebook photos.
They simply haven’t run enough miles. Read: They haven’t trained enough and lack a tangible base of mileage. In other words, their foundation is faulty.
Compound interest works the same way. Let me explain.
Albert Einstein is credited with saying that “compound interest is the eighth wonder of the world.” (This is the part of his legendary quote that most people remember; the next part is less well known.)
“He who understands it, earns it; he who doesn’t pays it.”
The story we’ve been told since grade school is that interest compounds and that’s what you want. For example, if you start with 100 dollars and earn a dollar of interest (1%!!) in the first year, in year 2 you will earn interest on 101 dollars. Interest not only accumulates on the original amount, but also compounds on the earned interest. And the hits keep on coming. Each year the interest (on the interest) will compound. That’s how money grows! Keep your money invested and it will keep growing – at a compound rate.
Somehow this concept was transferred to your stock market investments, which, unfortunately, don’t operate the same way. It’s a myth, much like if you run a race really, really slowly - you get more for your entry fee!
From my friends at www.realinvestmentadvice.com.
Compounding only works when there is NO CHANCE of principal loss. It’s a linear wealth-building perspective that no longer has the same effectiveness considering two devastating stock market collapses which have inflicted long-term damage on household wealth. (As you can see below, when the S&P 500 has hit highs over the years, it has taken, in some cases, decades to get back to the same place.)
What good is compounding when the foundation of what you invested in is crumbling? Or to continue our running example, you can have the best shoes, cool shades and the priciest heart-rate monitor, but if you didn’t have the heart to do the training it’s not going to matter. (See what I did there? Never mind!)
One more example…(Let say 100 dollars grows in scenarios 1 and 2 at the following rates. Year 3 in scenario 1 is a loss.)
The 7% returns in years 1 and 2 were nice but year 3 wiped much of the gains out. And it may seem counterintuitive that scenario 2 would win, but that’s exactly what happened.
(The tortoise beat the hare, if you will.)
The impact of losses, in any given year, destroy the annualized “compounding” effect of money.
If you experienced either one, or both, of the last two bear markets, you understand the importance of “time” related to your investment goals. Individuals that were close to retirement in either 2000, or 2007, and failed to navigate the subsequent market draw-downs may have had to postpone their retirement plans, potentially indefinitely.
To finish this post “in theme”, allow me the following:
We may be nearing the end of a long, long bull run. Yes, the finish line keeps moving further and further into the distance but still, it’s coming. It always comes. If you’re retiring soon, these concepts will increase in importance as time goes on.
The compounded effects of protecting your principal (the tortoise approach) will win.
Speaking of the tortoise, I’m going for a run.
That's just how it works!
That’s just the way it works!