If my great-great-grandfather bought a farm 175 years ago for 50 pounds, (which he did) and today it would be worth something around 3 million pounds, ($6,000,000) should I conclude that he was a brilliant real estate investor? After all results matter. 60,000 times the original investment is pretty good.
Well, yes and no. 60,000 times is about 16 doubles. 16 doubles in 175 years is one every 11 years. 6.5% annually compounded. How good is that? Maybe not so exceptional.
People do not intuitively understand exponential growth. Our intuition is linear not compounding. People must do the arithmetic to have a hope.
For example. When was it worth half? $3,000,000 Half the time? About 1930? Not likely. If the growth was constant it was worth half 11 years ago. 2005. Another double and here we are.
Looking at big numbers compared to small numbers and ignoring time is a way to get into trouble.
In investing, the time to double is a crucial variable. It ties your scarce element (time) to the market offerings. (Yield) Presumably your available capital is always the same.
You can readily make the calculations leading to responsible action if you know the rule of 72. The time to double in years is approximately 72 divided by the yield. Similarly, if you know how many doubles and the time it took to get them, you get yield by dividing 72 by the time for one double.
Knowing this is not about making you wealthy, it is about having you hold reasonable expectations about the market and the future values that are possible.
Suppose someone says they can make 18%. Roughly double every 4 years. How much would $10,000 be in 40 years? 10 doubles. 1,024 times the capital. A bit over $10,000,000. Maybe, but I want the “cannot do it” side of that bet.
I know a former day trader who claimed to be able to make 1% a day. Turned out wrong, but a cherished belief for a while. 1% per day the stock market is open, turns $10,000 into a one followed by 15 zeroes in ten years. A handsome portfolio. Sadly more than the value of all the stock on earth by a wide margin. Maybe 1% a day is harder than it looks.
Unreasonable expectations eventually become unmanageable and then what? Unreasonable goals kill success. It leads to under saving because I can catch up later, or it leads to disappointment after a short time. Then the resultant change in strategy or even quitting altogether.
Reasonable goals add meaning you can understand. Seeking and achieving reasonable goals builds strength, both financial and emotional. You need those.
Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.
Please be in touch if I can help you. email@example.com 866-285-7772