Sunday, April 18, 2021

What You Should Know About Stock Investing and Compound Interest

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For some conservative investors who are serious about compounding, equity securities may not sound like the most appropriate financial instrument for their portfolios. Stocks are often looked at with stigma attached because of their direct association with Wall Street, market volatility, and their potential for short-term loss. In other words, compound interest investors who shun stocks prefer not having to deal with their inherent risk; nonetheless, this has not stopped billionaire investor Warren Buffett from deriving more than half of his fortune from equity securities and without ever straying from his compounding philosophy.

Investment Portfolios, Short-Term and Long-Term

While it is true that $100 deposited in a high-yield savings account is several times safer than $100 used to purchase shares of companies traded on Wall Street, this is mostly a short-term philosophy. When you look at shares of companies such as Tesla Motors, which have climbed from $33 in January 2016 to more than $800 in January 2021, you see that real value can be derived from including stocks in your compounding portfolio. If, instead of purchasing a single TSLA share in early 2016 for $33, you had decided to open a $100 high-yield savings account compounding at 1%, your monthly contribution would have needed to be $12 over the next five years in order to match the growth of TSLA stock.

Imagine applying the compound interest rule of reinvesting and matching profits to a single TSLA share since 2016. By now, your portfolio would have grown considerably, and you would be the owner of more than a dozen TSLA shares. The risk would not have been insignificant, but the gains would have justified it. This is what Warren Buffett has done for decades; once Berkshire Hathaway makes a decision to invest, profits go right back into the portfolio, and more shares are acquired if the analysts predict future growth.

complete risk aversion could cause you to miss out on great opportunities

The bottom line of stock investing and compound interest is that complete risk aversion could cause you to miss out on great opportunities. Completely ignoring the potential of your money is also risky because your profits are barely staying ahead of inflation. Don’t forget that the time value of money runs on a declining scale, which means that the goals you see in the compound interest calculator will not be as valuable several years from now.

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