Compound Growth

Wisdom!

Growth is good.  Compound growth is better.  A related post outlines the difference between average annual growth and compound annual growth.  In this piece, I wanted to explore the benefits of compound growth in more depth.

One important characteristic of compound growth investors often find difficult to wrap their heads around is that compounding isn’t a straight line path to a wonderful stream of cash.  The greatest effects of compounding don’t happen right away, but at some point in the future.  The growth rate of a compounding investment accelerates over time producing a curvilinear path rather than a straight line.  This curve appears somewhat exponential, but isn’t exactly. 

While this type of curve produces solid results, it requires patience to stay the course until reaching the inflection point on the growth curve; the point at which compounding really begins to take off.  Unfortunately, many investors don’t stick with it until that acceleration point is reached, bailing out before harvesting the true gains they might have otherwise.

Here is an example of what I mean.

In this example, an investor started with $1,000.  She put her money into a dividend stock having a distinguished history paying 8% annually, letting dividends automatically reinvest each year.

You’ll notice that at the end of Year 1 she received $80 in dividends so we’ll call that 1x.  In Year 10 she received $160 dollars which was twice what she received in Year 1 so we’ll call that point 2x.  In Year 15 she received $234 which is nearly three times her Year 1 dividends in which case we’ll call that data point 3x.  Year 19 saw our investor receive $320 which is four times her Year 1 dividends so we’ll refer to that point as 4x. 

Since you get the drift, I won’t use more words, but instead post a chart.

Dividend Multiples	Years
1x	1
2x	9
3x	15
4x	19
5x	22
6x	24
7x	26
8x	28
9x	30

You’ll notice it took our investor 8 years to double her year 1 dividends, 6 more years to triple those divs, 4 additional years to quadruple them, and three years to reach 5x.  After that, she added another multiple to her original payment every 2 years. 

In the first 15 years her dividend stream compounded to triple her year 1 total.  In the second 15 year period, she saw the effects of compounding take off with her annual dividend multiple reaching 9 times hear year 1 dividend payment. 

This is what I mean about the powerful effect of compound growth not occurring out of the gate but somewhere down the track.  Consequently, it’s important for investors to stay the course.

It’s important to begin investing early and letting compound growth work for you for this reason.  If you’re a young investor or you have small children who’ll need college money in 15 to 20 years, you can do yourself a favor by putting money away early, even if it’s not a large sum.  Compounding can take a small sum and turn it into something big in the end.

By the way, if you’re wondering what the underlying principle was at various points along the way, below is a chart in which I’ve added that data.  Notice that during the 30-year period her final total is more than 10 times her original value.

Dividend Multiples	Years	Principle
1x	1	$          1,080
2x	9	$          1,999
3x	15	$          3,172
4x	19	$          4,315
5x	22	$          5,436
6x	24	$          6,341
7x	26	$          7,396
8x	28	$          8,627
9x	30	$        10,062

Having said all that it’s true that not all dividend stocks pay 8%, nor can you be guaranteed they’ll pay out at that rate 3 decades into the future.  It’s also true that inflation will eat into the figures above.  Although nothing in life is guaranteed, some things are more likely to occur than others.  Dividend streams from solid, blue chip dividend companies are about as reliable as you’ll find in the investing world.  If they remain consistent and you are patient, the math of compounding will take care of itself and you.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.