In his recent article titled – Why Compounding is so Difficult, John Neff explains why most investors will never hold compounders. Here’s an excerpt from the article:
How many billionaires are there in the United States? There is no definitive count. Most estimates put the number well below 1,000–with 927 being by far the highest estimate we have seen. Whatever the precise number, given the power of compounding, there should be many times the number of billionaires in this country than there are today.
Assuming a 10% annualized rate of return in the stock market over the last 100 years, a family needed to invest $72,000 in 1922 and then simply leave it alone to have around $1 billion in 2022. We have no idea how many families had that kind of money to invest in the stock market back in 1922, but whatever the number, we believe it was much larger than the number of present-day billionaires.
What happened to all those could-have-been billionaires? Why do more investors not reap the benefits of compounding? We believe the reason has surprisingly little to do with recessions, depressions, wars, financial crises, political crises, rising interest rates, inflation, stagflation, a global pandemic, or most adverse macroeconomic events.
The stock market’s return over the past 100 years includes all of these terrible things. Yet, the stock market still compounded wealth to the point where every $1 invested in the S&P in 1922 and left untouched would have become nearly $13,800 in 2022! Our conclusion: it is not adverse macro events that derail compounding; it is investors’ reactions to them. In short, investor behavior derails compounding.
Examples of such counterproductive behavior are well known to all of us: trying to sell before the next recession, trying to buy just before the next bull market, “repositioning” portfolios based on what is supposed to do better in the new paradigm, dumping stocks during a downturn, which deprives oneself of the means to eventually recover.
People do these things because they are intuitive, because these actions appear rational in the face of heightened concern and uncertainty. This is precisely why compounding over the long term is so challenging and rare: it demands counter-intuitive and seemingly irrational behavior.
One of our favorite Buffett maxims is that the stock market exists to serve investors, not instruct them. We think it speaks to the importance of distinguishing between the fundamental performance of a business and the price movement of its stock. Investors minding both can periodically be served by the stock market when business fundamentals and share price diverge.
Too often, however, investors are informed only by share price movements from which business fundamentals are then inferred. These investors are not served by the stock market. Rather, they are instructed by it and typically to their detriment when it comes to compounding.
You can read the entire article here:
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