“Most great fortunes are built slowly. They are based on the principle of compound interest.” – Brian Tracy
I could go on and on all day with quotes about compound interest but hopefully, you understand how powerful compound interest truly is, and if you believe in it, your goal should be to allow your money to stay invested for as long as possible.
Morgan Housel said it best “What I want to have is endurance. I want to be so unbreakable financially in the short run to increase the odds that I will be able to stick around as an investor for the stocks that I do own to compound for the longest period of time. If you understand the math of compounding, you know that the big gains come at the end of the period.
If you’re investing for 30 years, the biggest gains in dollar terms are going to come in the last couple of years. That’s how the math of compounding works. It just gets exponentially higher as time goes on. So to me, the number one thing that I want to do, and I think this is true for a lot of investors, is just maximize my endurance, maximize my durability as an investor. And I do that by having a reasonably high percentage of cash and having no debt. It’s not that I don’t want to take a lot of risk, it’s that I want to maximize for endurance.”
What does Housel mean by this? He is saying that compound interest sees its biggest value in the later years of compounding so your goal should be to never allow short-term events to stop compounding from working in your favor. These short-term events are the what if’s that could happen in life. Some examples are:
- Loss of job
- Major medical expenses
- Something that causes you to not be able to work
- Loss of a spouse
- Your business closing
- Many other unforeseen events
For some reason, we all have this view that these types of things happen to others but never to us. At some point in our lives, some drastic financial problem is going to happen, that is just how life works. Your goal is to be ready for this and have enough cash on the sidelines (a strong emergency fund) so you can handle whatever life throws at you without interrupting the compounding returns your investments are getting. This is where you can truly build wealth.
“The game that I want to play is acknowledging how ridiculously powerful compounding is and therefore increasing the odds that I will be able to stick around long enough for compounding to work. That’s the game that I want to play. And it might look conservative, but to me, it’s actually the opposite.” – Morgan Housel