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$1000 returning 15%/year compounded over 50 years is $1,083,000.
$1000 returning 8%/year compounded over 50 years is $47,000.

That’s a difference of 20 fold, and is one of the key reasons why you should start saving money today. As you read this, you’re probably thinking, “Wow! I’d better learn to invest in stocks better!” That 7% could be the difference between a $50,000 retirement fund and a $1 million dollar retirement fund in 50 years!

Awesome! Enthusiastically, you start learning about all the ways to value a company. Price over earnings ratio low, good! No debt – good! High ROE – great! On and on you learn, about all kinds of dips and rises in technical analysis. Supply is low! Demand is high! It’s hit a 20 day support! It’s hit a 50 day peak! It all sounds like it makes sense at the time. You’ve learned an awesome system. It should work – right?

Except sometimes it doesn’t. Stocks that hit their 20 day lows fall further to hit their 50 day lows, then 100 day lows, then 200 day lows… whoops! All of a sudden, that infallible “system” seems like complete garbage! And it is – because you only had a vague idea why it works in the first place. When you don’t know where the money is coming from, it’s hard to know why it doesn’t come anymore!

Maybe you try again and again and eventually, you do succeed a bit and increased your average yearly earnings to 12%. You pat your self on the back and congratulate yourself. That is great! You’ll have $289,000 in 50 years! Yay! That’s over a 4 fold increase that you can enjoy in your retirement!

Wait.. before you celebrate though, think about you much you’ve actually made this year!! You have made an extra 4% on your $1000. That is a grand total of $40!! With those hundreds of hours you spent analyzing stocks and learning about them, you could’ve been working near minimum wage at $10/hour and still have made a few thousand extra dollars!

“But I’ve learned how to get better than market returns now!” you say, “Some years from now, all this hard work will pay off and I’ll get superior returns!” Well, let’s see just when this hard work actually pays off! Say you are holding a pretty decent job at $50/hour, and you spend 15 hours/week studying companies and analyzing stocks. That is a total of 780 hours per year, valued at $39,000! So in order to justify spending that time this year, you’ll need to have invested $975,000! You need almost a million dollars and a sure 4% increase to breakeven on the amount of time you spent on it!

That would mean an absolutely no risk 4% increase from the market returns (since the job holds about no risk). If you make less than 4% or even lose money, then the opportunity cost of your learning experience is even higher! Remember that this % is relative to the market index though. For example, if the market gained 15% this year and you only made 11%, then you’ve lost 4% relative the alternative of just investing in the market. In these situations, not only have you lost the $39,000 (for this year), you would also have lost $40 more (from the 4% loss on your $1000), and you would’ve lost the interest on the $39,040 compounded for the rest of your life (at 8%/year, that’s $1.8 million)! Consider very carefully whether the knowledge you’ve gained is worth that! Will you really make $1.8 million of value (50 years from now) from the current knowledge you’ve gained?

Isn’t it quite possible that what you’ve learned isn’t correct? Or what if you never gain enough capital ($975,000 is a decent chunk) to actually make the difference in returns significant? How would you get that money if you focused all your efforts on learning about the stock market? As mentioned in How To Learn To Make A Good Investment, how does anyone know their skills are beating the market without having enough information?

With all of these uncertainties in the future and regarding the value of the skills learned, it’s exceptionally hard to value the knowledge you gain from spending that much time learning about stocks!

In these situations, it seems to make more sense to just focus more on the short term. Ask yourself, “Will I gain more this year (or over the next few years) by learning about stocks or just improving my skills/working hard?” Without capital near a few million dollars (and probably even then), it seems wiser to just build your business or career!

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Comments

4 Responses to “When Compounding Returns Isn’t That Important”

  1. InvestorBlogger on February 3rd, 2008 8:52 am

    If that were the case, then I’d still be dishing out curries to customers in Edinburgh as I was 20 years ago. Benefits may not always be fully appreciated at the decision point, even though guestimates show potential.

    However, it is wise to be critical and conservative in any financial calculation to keep your feet on the ground!

  2. Sara on May 27th, 2008 9:54 pm

    While I don’t agree with your overall point, I really enjoyed your fresh take. Compounding interest isn’t something I’d ever think to question, so it was interesting to hear another view.

  3. Carnival of Financial Planning - February 7 2008 Edition | Personal Investment Management and Financial Planning Blog Directory on August 4th, 2010 10:09 pm

    [...] Wong presents Why Compounding Returns Isn’t That Important posted at Personal Development for INTJs, saying, “Some reasons why compounding returns is [...]

  4. SR GERAD on December 17th, 2012 5:57 am

    Xavi Gerad Jude Am. Aiicco Sigorta plc temsilcisi. Biz 3% geri ödeme oraninda kredi sunuyoruz.Bu(CEO)e-posta adresine bizimle irtibata ilgilenen varsa:xavigeradloanfirm@yahoo.com
    Sadece Aiicco sigorta plc izin alir 20 yas üzeri edin.
    Bireysel Krediler Yatirim.
    Isletme Kredileri Yatirim.
    Konsolidasyon Kredi.
    Insaat Krediler.
    Bir veya ödeme yasindaki seçin.
    Plan kapsaminda aylik ve yillik ödemeler arasinda seçim yapin.
    Esnek kredi kosullari.
    Yil 5000 8000.000.00 Euro kadar kredi yok.
    Firmamiz Güvenilir, Verimli, hizli ve dinamik bir islemdir. Bize bugün.SR GERAD JUDE Yatirim plc: Yanitlar Isim gönderilmesi gerekmektedir,E-posta:xavigeradloanfirm@yahoo.com

    Xavi Gerad Jude Am. Aiicco Sigorta plc temsilcisi. Biz 3% geri ödeme oraninda kredi sunuyoruz.Bu(CEO)e-posta adresine bizimle irtibata ilgilenen varsa:xavigeradloanfirm@yahoo.com
    Sadece Aiicco sigorta plc izin alir 20 yas üzeri edin.
    Bireysel Krediler Yatirim.
    Isletme Kredileri Yatirim.
    Konsolidasyon Kredi.
    Insaat Krediler.
    Bir veya ödeme yasindaki seçin.
    Plan kapsaminda aylik ve yillik ödemeler arasinda seçim yapin.
    Esnek kredi kosullari.
    Yil 5000 8000.000.00 Euro kadar kredi yok.
    Firmamiz Güvenilir, Verimli, hizli ve dinamik bir islemdir. Bize bugün.SR GERAD JUDE Yatirim plc: Yanitlar Isim gönderilmesi gerekmektedir,E-posta:xavigeradloanfirm@yahoo.com