Big Picture: Is Compounding Growth Working For or Against You?

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I’m a finance geek and like to dig around in the details like asset allocation or tax strategies. However, sometimes I read some news that reminds me to step back and look at the big picture. Half of all Americans don’t own any stocks at all. Before the 2008 financial crisis, about 2/3rds of US adults had some skin in the stock market, but that number dropped significantly and hasn’t rebounded. From a Gallup poll:

Even out of the half of Americans with some amount of stock ownership, most of them have no idea about stock market performance. Betterment conducted a survey [pdf] asking people to estimate the US stock market performance since December 2008, and Axios made it into a nice chart. Note that all of the respondents in the Betterment survey stated they had at least $1 invested in the stock market.

About half of respondents either thought the stock market dropped or stayed the same over the last 10 years. The correct answer is that the stock market is up over 200%. Only 8% of people who own stock got this right.

I worry that this means that only a small percentage of people are aware of the potential power of investing in productive assets like businesses. Sure, 200% is a lot, but over 10 years it’s not an insane number. At 12% annual growth, your money doubles in 6 years and thus quadruples in 12 years. At 8% annual growth, your money doubles in 9 years and thus quadruples in 18 years. Even at 6% annual growth, your money will double in 12 years and thus quadruples in 24 years.

Owning productive assets like public companies, real estate, or private business ownership gets you on the train powered by compounding exponential growth. Debt like student loans, credit card balances, even a home-equity loan for a new kitchen remodel, that’s like putting the compound interest engine in reverse. I know that it is easier said than done, but one of my favorite quotes from Mr. Money Mustache is that you should treat “debt as an emergency”. The difference between even putting a $50 into stocks a week, versus paying $50 week in interest to carry your debt each month can become the difference between having choices and the treadmill lifestyle forever.

If someone realizes the power of compounding, then they are more likely to covet that rental property or share of Apple stock as much as a new BMW lease or Viking stove. I love buying new shares of VTI. It gives me a dividend gift every quarter. This appreciation is the key to the constant accumulation of productive assets and not stuff.

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  1. Great post. A car loan is probably another debt that many people don’t think much about. As long as they can make the monthly payment, they figure they can afford it. It’s an easy trap to fall into for most. In fact, both my parents and in-laws view their finances mainly from the perspective of cash flow (not net worth) and always have. They have a certain amount coming in from pensions, SS, etc. and therefore can afford to spend this much per month.

  2. So it sounds like what you’re saying is that I shouldn’t be financing my home theatre system with credit cards and instead I should invest the money into the stock market?
    Crazy. Talk.

  3. I wonder if some of the effect is from boomers reducing their risk while in retirement.

  4. This poll pretty much says “I don’t know” as a response, with half saying up, half saying same or down, and the most common answer being the same or slightly up. That is surprising given the respondents are all stock holders.

    But it is not the most striking part for me. That surprise is reserved for the 9% of people who believed the stock market had dropped more than 100%, which is mathematically impossible. If it were possible, those who had owned stocks would now I guess owe money (twice as much as what their investment had been for 5%) beyond having lost their whole investment value somehow.

    • Clarifying my ( ) comment above — (in fact losing more than twice as much as their investment, so now owing more than their original lost investment to some mythical creditor according to 5% of those polled). Wow.

  5. 9% of surveyed adults estimated that it dropped more than 100% ??? Did they not understand the question, or are they really so clueless?

    • @David, rhetorical question, right?

      Personal Finance should be taught in middle school (high school is too late for that).

  6. cant believe how ill-informed most people are. this is sad

  7. People should stop viewing things like cars as valuable assets and instead focus on investing in things that yield them high returns.

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