When it comes to investing, time trumps rate of return
In 2005, the novelist David Foster Wallace gave a commencement speech at Ohio’s Kenyon College. He began:
“There are these two young fish swimming along and they happen to meet an older fish swimming the other way, who nods at them and says, ‘Morning, boys. How’s the water?’ And the two young fish swim on for a bit, and then eventually one of them looks over at the other and goes, ‘What the hell is water?’ ”
Mr. Wallace went on to say that the point of the fish story is merely that the most obvious, important realities are often the ones that are hardest to see, and to talk about.
In both life and that small subset of life known as investing, one of those realities is time. Despite its importance, time is impossible to see. It is definitely worth talking about.
How does this apply to investing? Well, investing is simply putting money aside today with a view to getting back more money after some time has elapsed.
Because invested money grows exponentially, the combination of a reasonable rate of return and the passage of time will result in a satisfying creation of wealth. Of course, the higher the rate of return, the greater the wealth creation.
Your return will increase far more dramatically with time, a factor which we too often miss.
Because we live in time in much the way that a fish lives in water, we tend to ignore it. But here’s the thing. Your rate of return over a short period of time has little effect on the ultimate amount of your wealth. It is only your average long-term rate of return that matters. If you are a competent investor and you invest in one of the better-performing asset classes, such as stocks, your very long-term average annual return is likely to fall between 6 per cent and 10 per cent.
Your time period can vary far more than your rate of return. Let’s assume your very long-term rate is 8 per cent. That will multiply your money 2.2 times over 10 years. However, it will multiply your money more than 10 times over 30 years, and more than 100 times over 60 years. And so on. It’s primarily time that drives the only return that matters.
As author Morgan Housel has succinctly put it, “Time is the exponent that does the heavy lifting, and the common denominator of almost all big fortunes isn’t returns; it’s endurance and longevity.” If you doubt this, ask yourself how Canada’s wealthiest families came to occupy that position.
Clearly, it’s important to invest, and add incrementally to your investments, at as early an age as possible – and to not interrupt the compounding of your capital.
As we all swim through the waters of time, these are ideas worth keeping in mind.