The Power of Compounding

Everyone hears about the power of compounding as one of the best ways to build wealth, but do we truly understand it?  Can you visualize this super secret force that people tell you will eventually work its magic and poof, one day you have bag and bags of money?  I truly believe people are visual learners and by seeing it, people tend to understand it.  Compounding is not different.  It’s just a word or thought until someone can really put is on paper and see what it really does.

I bought my first mutual fund outside of my 401k on March 10, 2008, which in retrospect was fantastically bad timing, but it’s also why they say that you don’t try to time the market.  At the time I was still newer to investing and was just starting to dabble in things on my own for the first time rather than just have my 401k do the work for me.  I did my research and settled on Vanguard due to the low cost nature and because of the positive word of mouth from other investors and review sites.

I ended up buying 326.797  shares of Vanguard Wellington Fund Investor Shares (VWELX – closed to new investors) at a price of $30.60 for a cost of $10,049.99.  This was basically all of my free cash in my Roth at the time and I needed to have some exposure to the markets.  Pretty soon we all know what happened because the market tanked, and boy did it tank hard.  There was a blood in the streets mentality and people wanted nothing to do with stocks.  I watched my new found investment drop all the way to $20.65 on March 9, 2009.  So my $10,000 invested a year before literally dropped all the way to roughly $6750.00 in a year.

Like most people this was discomforting, but I didn’t touch the money, didn’t feel the markets, and didn’t panic.  Tough to do when the world around you is on full on freak out mode, but part of the important parts of an investment philosophy.  You need to understand your risk appetite and what you are willing to stomach.  For me to be young and have decades to go for things to grow I stopped checking markets daily and just kind of let it ride.  I set the fund to drip in 2009 and just sort of forgot what I initially bought, how many shares I had and what the income was from it.

To understand it VWELX paid me $69.17 in March, $82.44 in June, $71.48 in September ,and $85.93 in December in dividend income.  This totaled $309.00 and another 1.782 shares of the fund.  Fast forward to 2017, almost ten years since I first purchased the fund and less than a decade of fully reinvested gains and dividends.  January paid me $106.98, June was $119.44, September totaled $116.93, and December rang the register with $130.10.  This gave me a grand total of $473.44 in dividend income, a 53.22 % in income over a period of less than a decade.  That’s a pretty nice raise by any stretch of the imagination.  When was the last time you increase your income at work by over 50% in less than ten years with no effort?

This also doesn’t include those years with capital gains either, just last year the fund had over $400 of capital gains reinvested into it as well. Every year the market goes up the fund has gains that get reinvested, further enhancing the rate of which my snowball grows.

I did mention that this is all about compounding so let’s take a look at share growth.  Keeping in mind I started with 326.767 shares on day one, in less than a decade I’m up to 490.60 shares.  This is in line with the dividend payout change with an increase of 50.2% of shares.  That’s an incredible increase and what’s even more incredible than having that rate of increase?  The fact I didn’t have to do a darn thing, but let it sit and compound over time.  This 50% increase was accomplished in only eight years of dividend reinvestment, so in less than a decade my investment is 150% of the initial investment and only continuing to increase.

I always hear people throw out lines that compound interest is the most powerful force in finance, but I rarely see people run numbers to back it up.  Seeing it and writing about it really puts it in perspective when you look at your own accounts.  This exercise for me was eye opening on my account since I had never done it, but something I would encourage you to do for yourself to see what your finances are truly doing for you.

Perhaps one of the greatest investors of all time can sum it up nicely:

“My wealth has come from a combination of living in America, some lucky genes, and compound interest.” – Warren Buffett

Oh and you may wonder what that initial $10,049.99 is worth now?  The market value is actually $19,906.60 which is just shy of double what the initial investment was.

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3 thoughts on “The Power of Compounding

  1. I love the DRIP strategy. I have turned them on in all of my index funds and a couple of my stocks. It’s so nice not having to worry about what to do with the money. I figure if I like it enough to buy that I’d like to buy more in the future using dollar cost averaging. So watching the number of shares that I own each year go up is a really nice feeling. Great post and I can’t believe 2008 has almost been 10 years ago…yikes

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  2. Thanks! I feel the same way about 2008, I mean I really had just started in the market and it’s crazy to see what time has done. Been a heck of a run since then and can’t wait to see what the future holds.

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