Power of Compounding

My favourite illustration of the power of compounding growth is the story of what happens when a piece of paper is repeatedly folded in half. At the first fold, the paper doubles in depth. At the second fold it doubles again, to be four times as thick as it was at the starting point. The astonishing point is how few folds it would take for that imaginary tower to get halfway to the moon. The answer is a mere 41 folds. And from there, all it would take for that tower to reach the moon is one more fold. Not easy to get your mind around!

Many of the first principles in long-term investing stem from the fact that financial returns are path-dependent and accrue in a geometric (or non-linear) manner. Two of these investing principles are relevant here:

The power of compounding – why small numbers get big on you over long periods of time.

South African equities have delivered a real return of 8.7% per annum since 1925. This may not sound like a big number but, this annual return would have grown any capital invested at that time by a breath-taking 1 343 times (in inflation-adjusted terms). It is often said that diversification is the only free lunch you get in investments. I would rate the power of compounding (over long periods of time) even higher.

Extract from the Correspondent of January 2016, written by Karl Leinberger