The magic of compound interest and long-term investing

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The magic of compound interest and long-term investing

I see many people, nowadays, that believe that speculation is much better than long-term investing. I wanted to show one of the main reasons I endorse staying long-term in any market. This article is not just about cryptocurrency. This is how the magic compound interest shows in a longer period, in any investment.

Speculation: why it is not good and how it can be dangerous

Speculation, sometimes, can produce some big returns. History has proven that it lacks long-term sustainability and is damaging economically. This is what I believe, too, and I will explain why.

Let’s take the worldwide economic crisis of the late 2000s. The cause of it was the speculation of mortgages taken one step further: mortgage derivative securities. These securities started to contain garbage loans, which had a very high probability of defaulting. The market’s need for higher returns, together with the over-optimism, was the reason why this happened. At one point, they contained so many bad mortgages that started defaulting. This caused a sudden value loss. These small derivatives, in which investors poured tons of money, have caused such a crisis. The speculation, together with the greed programmed in our genes, has caused damage that had repercussions in all of the markets (real estate, stocks and so on).

I want to remind you that the creator of Bitcoin, Satoshi Nakamoto, created this cryptocurrency in order to replace fractional-reserve banking and the entire set of factors that cause economic instability. He had not created the concept of cryptocurrency in order for people to speculate it. He wanted people to stop doing what they have done in 2008, 2000 (dot-com bubble) and many times along history. His vision was to create something that will cause long-term and sustainable economic stability. So, at least in the cryptocurrency market, people should look towards long-term investing because it might be the way to make this a stable and established market, that is as serious and as good as the stock and the commodities markets.

Case study: The S&P 500 index

The S&P 500 index is one of the most elementary in the stock market. There are plenty of ETFs following it. It is considered the best instrument that reflects the direction in which big company shares go. This means you are not exposed to a certain industry going down because of regulation or something else. It also means that you are exposed to crashes, corrections and so on of the entire stock market. At the same time, the biggest companies are the safest investments. This index is the ABC of stock market investors.

Many top-tier, institutional investors have tried to beat the S&P 500 index. Although it might not seem hard on paper, it has proven to be a very hard challenge for the best of the best. Let’s look for example at Warren Buffett’s Berkshire Hathaway, relative to this index:

Source: Google Images

As you can see, there are many years in which even the most prestigious stock market investor was not able to beat the index. At the same time, there were years in which it outperformed it badly. But, looking at the chart more, we can see it has proven to be harder and harder to beat this index and that Berkshire’s relative performance is seeing a down trend.

For investors that want to win passively, the S&P 500 seems to be one of the best options out there and it has proven to obtain, on the long-term, an average of 8% annual return. This does not seem great, but, together with the magic of compound interest, it shows amazing results. Since there are also some companies that offer dividends in this index, let’s look at how your investment would grow over the years, if you were to reinvest your dividends and hold tight on the index.

The magic of compound interest: long-term savings plan with the S&P 500 index

Let’s make a simulation. Let’s say you invested $500/mo for 30 years in the S&P 500 index, with dividend reinvestment. Using an online tool, we get the following data:

The magic of compound interest: proof with long-term S&P 500 performance
S&P return between January 1989-January 2019

Investing $500/mo for 30 years would have produced you almost $3 million dollars. This is where the magic of compound interest appears, over long spans of time. This is why I love long-term investing. All of this could have been done passively and if you were to keep this money in a checking account it would be only $180k, which is not much (you can’t even buy a decent-sized home in a good neighbourhood with this amount). If you were to keep it in a 2% APY savings account, it would only be $300k (10% of what the S&P savings plan would have offered you).

Conclusions

Even though I have mainly analysed the stock market in this article, this applies to any value investment in general. This is applicable to cryptocurrencies and commodities passive investments too. The magic of compound interest shows in longer timespans. This is why I love long-term investing, which does not cause repercussions in the market, unlike speculation. If you want to be more involved, keep in mind that it is very hard to beat big players (for the stock market, the S&P 500 and for the cryptocurrency market, Bitcoin mainly – which has a +50% dominance at the moment). Establishing a good investment strategy early is good for long-term results. If you are willing to share some new ideas, make sure to leave a comment below. I am open to any chats, therefore, don’t hesitate to use this link

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