The Time Value of Investments Comes at the End
While reading The Investment Zoo by Stephen Jarislowski recently, I noticed one interesting phrase he brings up repeatedly: if your investments double in 7 years, half your portfolio will be built in the last 7 years of growth. He likes to throw around 10-15% returns while I base my plans on a 5% real return (14 years to double), but it’s still a valuable perspective to keep in mind.
This is what’s really going on with the old compound interest math trick where you compare someone who invests for 10 years only, starting now, against someone who waits 10 years and then invests until they retire but ends up with less. The difference happens at the end because the first person gets another 10 years of growth which means another doubling or more.
When you’re starting to invest this is important because every year you wait counts. The gains might be slow at first, but if you invest for 40 years with doubling every 7 years the first 33 years will only account for half of your portfolio. As strange as it might sound it’s the expected first step (or first 33 steps) to the end result. On the other hand, when you’re getting closer to living off your portfolio this is important because letting it grow a bit longer can have a big impact in the right conditions. Even if you stop investing but keep earning enough income to cover spending you might double the investment income you get later.
This is just the power of steady compounding. Higher returns that don’t last can’t compare to repeated doubling of your portfolio. In fact any rate of return may not be meaningful to a lifetime income plan unless you can get it consistently for 20-40 years with little extra effort. Buy and hold fits that; chasing a growth stock and knowing you have to get out before it dies in the next 3-5 years and then find another growth stock doesn’t.
In other words, the length of time you are invested is sometimes more important than the amount you invest or the rate of return you get. As usual with sound investments, it’s hard to impress people by going around saying “I’ll be in this investment for over 40 years!” instead of “I made over 40% on this!”. But even those of us who know that we should take advantage of compound interest can easily forget the full value it gives us.
My plan is a bit different since I want to invest heavily and shorten the time until the portfolio income can pay our expenses. This relies less on compound growth over time, but any additional, unplanned growth from waiting longer will be that much more valuable as a result.