Update 2.22.2021: The Dow Jones Industrial Average Index closed at 31,494.32.

Originally posted August 3, 2018.

This week a long-time reader contacted me looking for some insight he could pass along to his children about the dangers of market timing. I’ve written on the topic many times over the years and wanted to share something he might find compelling. In April of 1996, I wrote about how three of Wall Street’s bright minds had completely failed while attempting to make market timing predictions about the future of the Dow Jones Industrial Index. Back then my advice was—as it is now—marry compound interest, divorce market timing. I wrote:

Market timing is a bankrupt strategy whose time has never come. The following three market predictions will alarm you. (Keep in mind, the Dow is now over 5500!) (1) On 24 February 1995, from the head of a major Wall Street investment management firm, “We won’t materially break 4000 until well into the next millennium.” (2) On the same date, from the head of institutional equities at a major brokerage firm, “Dow 5000 is not going to happen in my lifetime.” He’s still alive as far as I know. (3) On 25 May 1995, from a well-known market cycles technician, “This high (Dow) represents a gift last-chance selling opportunity (Dow 4500) before the big bear growls at the Dow. We expect the largest decline in stock prices since 1990.” Each of these forecasts was a disaster, of course, and cost followers of this advice a bundle in missed opportunity.

I have never in 32 years of investing suffered so much as one significant loss—not one. This is because I invest for the long term keyed to harnessing the awesome power of compound interest. The key to Warren Buffett’s long-term success has been buying easy-to-understand companies with unmatchable franchises and holding for the long term to allow the miracle of compound interest to do its work. If you marry compound interest and divorce market timing, you will find prosperity beyond your wildest dreams. If I can help you in only one way in your personal investing, it is to first and foremost harness the awesome power of compound interest through low-turnover, low-cost, long-term investing.

By the end of 1996 the Dow was trading well above 6400 and has never fallen below 6000 again. The market timers’ predictions were completely wrong. Building a strategy based on compound interest and regular streams of income in your portfolio was absolutely right.

Ken, I hope that helps, and thanks for all the years of loyalty. After over five decades I haven’t changed my investing strategy, and I hope you won’t either if you’re investing along with me.

Lack of patience, more than anything else, hamstrings investors in their pursuit of profits. I wrote in July 2004 that impatiently trading in and out of equities with no eye toward compound interest will bring investors everlasting sorrow.

Compound Interest and You

Here’s a compound interest story that should help you and your spouse. Let’s assume a hypothetical $10,000 investment with a 7% annual return for 20 years. Investor A draws the 7% ($700) each year for living expenses. At the end of 20 years, the original $10,000 in capital remains in place, and $14,000 in simple interest has been drawn for living expenses. The end value in capital and interest drawn is $24,000. Now let’s assume hypothetical Investor B invests the same $10,000 at the same 7%, but draws nothing and simply let’s the money compound for 20 years. Well, $10,000 compounded at 7% for 20 years has an end value of $38,696. You will see that $14,696 ($28,696 – $14,000) represents interest on interest. Over half of the long-term total return for Investor B reflects interest on interest. Unfortunately, compound interest is not a concept that is well understood by most investors.

To their everlasting sorrow, most investors not only lack a basic knowledge of compound interest, but also lack patience and dividend/interest religion. Many are greedy, trade way too often, and are in debt. For the record, I have no debt. I buy for cash. I have never employed margin and tend to own the investments I make for a long, long time.

Retired and soon to be retired investors should place their confidence in the unmatched power of compound interest.

Back in January of 1987, Ronald Reagan gave a State of the Union address in which he lamented the brutal war being waged by the Soviet Union on the people of Afghanistan. Behind the scenes though, Reagan was operating what has become popularly known as “Charlie Wilson’s War.”

Reagan and his supporters in Congress, including Charlie Wilson, were sending Stinger missiles to the Afghans fighting against the Soviets. Those missiles cost pennies on the dollar compared to the Soviet MI-24 Hind gunships they were used to target with a lethal 79% successful kill rate.

The mere pennies the U.S. was spending on the war against the Soviets really added up. The massive cost of the war was a major contributing factor to the eventual breakup of the USSR.

The same month Reagan gave his address, I was writing to subscribers to encourage them to realize the value of their hard-earned pennies.

That month I wrote:

I’ve told you about the vital importance of dividends and compound interest. At a 10% return, money doubles in only seven years. One member of the highly successful Rothschild family referred to compound interest as the eighth wonder of the world.

I’ll always remember Bob Rose’s historic note in The Wall Street Journal a while back. Bob wrote, “Early in the last century, an English astronomer, Francis Baily, figured that a British penny invested at an annual compound interest of 5% at the birth of Christ would have yielded enough gold by 1810 to fill 357 million earths.”

When put into terms of earths worth of gold, it is easy to see the value of compounding. All the mined gold in the world today would fit into a 68-foot cube. The idea of 357 million earths volume of gold is incomprehensible, but it makes the point Baily was getting at. A small investment can generate a powerful return.

At the end of his speech, Reagan told the American people “my fellow citizens, America isn’t finished. Her best days have just begun.” It was true. American went on to win the Cold War, becoming the undisputed most powerful nation on earth. It all started with an investment of what seemed like pennies in Afghanistan.

If you harvest the power of compound interest, your best investing days have just begun as well.

Back in 2006 I was celebrating 20 years of writing Intelligence Report. Debbie and I were in Vermont, and had just visited Vermont’s Authentic Designs to purchase lighting fixtures. The shop uses 150 year-old machines to manufacture colonial and early American lighting fixtures. There, on one of the machines for all the craftsmen to see was taped a sign that read “Simple is Sophisticated.”

After reading that taped up sign in Vermont all those years ago, I adopted “Simple is Sophisticated,” as a personal mantra to keep me focused on the essential elements of my investment strategy. The most fundamental of these, and the one I have employed to the greatest benefit to myself, and hopefully to you if you have been a subscriber or client, is compound interest. Below you will read the story of how I have employed compound interest to the benefit of my grandchildren, and how you can do the same. I wrote back in May of 2006:

Rich as Croesus

I want you to begin on your quest for sophistication through simplicity by focusing laser-like on compound interest. Here is an amazing story. I call it my grandchildren’s “rich as Croesus” strategy. (Croesus was the last king of Lydia from 560–547 B.C.)

When each of my four grandchildren was born, I opened accounts for them at Vanguard’s TaxManaged Growth & Income fund. Each year, I deposit $10,000 (and yes, I know you can now give away $11,000/year tax-free). The money is invested with little in the way of long-term tax implications. Let me show you how compound interest works its magic.

Gettin’ Rich Slowly

If you invest for a compounded rate of return of 10%, it’s easy to think that your long-term return would be twice the return gained by investing at 5%. That is not the case—not by a long shot. Let’s take a long-term look here, for that is my intention with my grandchildren. Investing $10,000 at 5% for 50 years gives them $115,000—a staggering sum, to be sure. But at 10%, $10,000 grows to a mind-boggling $1,174,000 (that’s million). Double the growth rate to 20% (admittedly unrealistic, but useful in this example), your $10,000 would become a stratospheric $91 million (over 77 times the return). And you thought you understood compound interest?

You and Counterbalancing

As noted, a 20% annual return year after year is unrealistic. But you can achieve really terrific success, most conservatively, by counterbalancing your portfolio with fixed-income and common stocks. …

In 1989, the editors of Fortune published an article headed, “A Low Risk Path to Profits” profiling Loews Corp. money manager Joseph Rosenberg. Fortune noted that J.R. believed so fervently in the awesome power of compound interest that he carried a compound interest table in his pocket at all times. Sayeth J.R., “It is the most important thing in investing.” As the article noted, it’s foolish to undermine the power of compounding by taking big risks that kick you out of the game.

As Rosenberg noted then, compound interest “is the most important thing in investing.” If you want to succeed as an investor for your family, your grandchildren, or yourself, stay focused on the simple, yet sophisticated strategies that really make a difference.