Had one of your ancestors invested a dollar in stocks back in 1802, and had all subsequent heirs left it there to build, you might now possess a portfolio with a real, after-tax value of $43,100.
Such is the power of compounding, about which you'll hear very little today in a market of relatively short-term thinkers - a market in which anything over six months is deemed by tax people to be long-term.The failure to appreciate the values inherent in the longer term may be one of the severest criticisms that can be made of popular investment thinking today, in which a 50 percent return in one year may actually disappoint.
The illustration is hypothetical, of course, since no vehicle existed 190 years ago to invest in the total equities universe, and chances are that if forced to pick just a single stock, your forebear might have chosen poorly.
But the number isn't one to be dismissed, according to Professor Jeremy Siegel of the Wharton School, writing in the latest issue of the "AAII Journal," published by the American Association of Individual Investors.
In fact, that $43,100 figure hardly conveys the full power of compounding, which begins slowly, builds strength and then can overwhelm even the taxman and inflation. The nominal value of that $1 investment would have been $955,000 in 1990, and its value after inflation but before taxes would have been $86,100.
In arriving at real values, Siegel wrung out inflation, which at the consumer level averaged 1.3 percent from 1802 to 1990. Tiny as that seems, it produced an 11-fold increases in prices, still another lesson for today.
While compounding can produce such spectacular results given a certain amount of time, it is hardly held in great favor by either investors or their brokers. Price movements are watched in terms of days or even hours rather than months or years. Daily price changes are headlined. Spectacular returns are advertised loudly, and the plunge that follows is hardly even mentioned.
Meanwhile, small amounts left in good stocks manage to weather the ups and downs of booms and busts, growing slowly but without the dilution of broker commissions. The more they age the faster they grow, thanks to compounding.
One of the clearest illustrations of the latter is likely to be provided by the answer to this seemingly simple question:
If you were offered a job in which you would have your choice of payments, which would you choose: One cent to be paid on day one and compounded at 100 percent each day for 30 days, or $5,000 paid in advance?
The latter would appear to be a pretty good deal: A sizable sum, perhaps more than you're earning now, and you get it up front, whereas the latter seems niggardly, and you'd have to wait for it.
But, of course, it would be worth the wait - 10,000 times worth.