When do you see effects of compound interest on net worth?

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masonstone
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When do you see effects of compound interest on net worth?

Post by masonstone »

At what multiple of net worth do you feel that compound interest adds to annual net worth increase more than income?
Last edited by masonstone on Fri Sep 27, 2019 8:41 pm, edited 1 time in total.
Prettyfrtnt
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Re: When do you see affects of net worth?

Post by Prettyfrtnt »

I’ve done these calculations a lot.

For me my own income becomes a minimal addition to net worth at around 10x my yearly pay invested into the three fund.

Use the governments compound interest calculator with your base amount in the market and then change month additions from zero to your salary (or savings rate). For me it starts to really not make a huge difference around 10x.
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Re: When do you see affects of net worth?

Post by DVMResident »

This is a simple math question and easy to calculate, with the answer depending on your assumptions.

The concept is discussed in the book “Money Ratios” if you would like to read on the topic.
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Re: When do you see affects of net worth?

Post by Kenkat »

About 10x sounds right to me.
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Re: When do you see affects of net worth?

Post by averagedude »

DVMResident wrote: Fri Sep 27, 2019 8:24 pm This is a simple math question and easy to calculate, with the answer depending on your assumptions.

The concept is discussed in the book “Money Ratios” if you would like to read on the topic.
Ahh, "Money Ratios". Now that was a great book that i enjoyed. Highly recommend it for math and investment nerds like me.
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Re: When do you see effects of net worth?

Post by Wiggums »

I do t know the answer, but I’m going to GUESS and say 8 times.
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Re: When do you see effects of net worth?

Post by LadyGeek »

This thread is now in the Investing - Theory, News & General forum (theory). I also changed the spelling in the thread title "affects" to "effects".
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Re: When do you see effects of compound interest on net worth?

Post by Chrono Triggered »

When your returns dwarf your contributions.
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Re: When do you see effects of net worth?

Post by masonstone »

LadyGeek wrote: Fri Sep 27, 2019 8:31 pm This thread is now in the Investing - Theory, News & General forum (theory). I also changed the spelling in the thread title "affects" to "effects".
Thank you for the correction :)
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Re: When do you see effects of net worth?

Post by Laika »

The multiple is only one part of the equation. Another important part is the prevailing interest rate. With 2%, you may be looking at a far larger multiple than with 5% or 10%. That said, I'd rather suggest thinking about the end result. An example alternative:

When will the income produced by my prudent investments equal the income from my employment?

Many of us will never reach that point (except by retiring, when work brings in $0), but many with modest jobs but larger portfolios will. Reaching that point is a major accomplishment, and is my answer to your question.
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Re: When do you see effects of compound interest on net worth?

Post by targetconfusion »

Wouldn't the formula be the same for everyone: 1/[aggregate investment return]?

E.g., if we use Burton Malkiel's average large cap equity return from the Bogleheads wiki, which is 12.3%, it's a bit over 8. If we use Bogle's expected 10 year bond return from 2017, which is 3.1%, we get around 32.

https://www.bogleheads.org/wiki/Histori ... ed_returns
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Re: When do you see effects of compound interest on net worth?

Post by Cycle »

U'll see accumulation pick up steam after you get like 2X income in savings; however our income won't really be optional till we are like 8x-10x. 10x is our FIRE target (3.4MM). Your target would depend on your spending needs.

But the market could be flat for many years. The only thing within your circle of control is your savings rate.
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Re: When do you see effects of compound interest on net worth?

Post by MNGopher »

I'll just say I was feeling pretty happy when during the first half of 2019 my investment returns exceeded my income. The 3rd quarter has reminded me that it can't do that forever.
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Re: When do you see effects of compound interest on net worth?

Post by livesoft »

When your portfolio drops in value in a single day by the price of a new Tesla. I find people don't see effects of gains, but do see the effects of losses.
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Re: When do you see effects of compound interest on net worth?

Post by essbeer »

It's tricky because people say you should include your home value in net worth, which is really more of an anchor on your wealth growth than anything else. I'm approaching 45x income in net worth and dividends are only about 50% of my cash flow now. Income is still really important.
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Re: When do you see effects of compound interest on net worth?

Post by Laika »

Cycle wrote: Fri Sep 27, 2019 8:52 pm The only thing within your circle of control is your savings rate.
Yes, but still debatable when facing job loss, unexpected liabilities, etc.

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Re: When do you see effects of net worth?

Post by chuckb84 »

LadyGeek wrote: Fri Sep 27, 2019 8:31 pm This thread is now in the Investing - Theory, News & General forum (theory). I also changed the spelling in the thread title "affects" to "effects".
Your so write about that :).
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Re: When do you see effects of compound interest on net worth?

Post by OCDinvestor »

When you stop looking!
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Re: When do you see effects of compound interest on net worth?

Post by masonstone »

livesoft wrote: Fri Sep 27, 2019 9:02 pm When your portfolio drops in value in a single day by the price of a new Tesla. I find people don't see effects of gains, but do see the effects of losses.
That’s happened to me several times over the past two years 😏
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Re: When do you see effects of compound interest on net worth?

Post by jsprag »

There’s been a few other conversations on this topic, including here and here, that have additional perspective (including the near-inevitable protestations of using “interest” and “compound” in the context of equity growth).

For me, it was when monthly variations in portfolio value (up or down) regularly exceeded the amount of my monthly contributions.
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Re: When do you see effects of compound interest on net worth?

Post by jh »

.....
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Re: When do you see effects of compound interest on net worth?

Post by Sheepdog »

When do you see effects of compound interest on net worth?
When I look at a holding which provided only interest over less than two decades: I bought $75,000 worth of I Bonds from June 2000 to October 2001 and see today they are worth $207,526.
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Re: When do you see effects of compound interest on net worth?

Post by Dandy »

For me it was when the growth of my nest egg was approaching my contributions. I felt the wind at my back as my portfolio was working as hard as I was saving. e.g. I was putting in 20k and the portfolio grew 40k.
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Re: When do you see effects of compound interest on net worth?

Post by abuss368 »

It does not take long to start to see the impact. I would say once you have a portfolio of 8 - 10 times income you can start to see the investment gains (and losses) start to overtake the impact of new money being contributed.
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Re: When do you see effects of compound interest on net worth?

Post by snackdog »

Many of you have yet to see your investment losses exceed your income. That's when you know you have some interesting savings.
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Re: When do you see effects of compound interest on net worth?

Post by masonstone »

snackdog wrote: Sat Sep 28, 2019 7:26 am Many of you have yet to see your investment losses exceed your income. That's when you know you have some interesting savings.
I actually felt that in 2018
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Re: When do you see effects of compound interest on net worth?

Post by Dude2 »

If you are talking about fixed income, then, ok, let's talk math, no problem. What I don't comprehend is how people apply the concept of compound interest to their stock holdings. There are no guarantees of value with stocks. You may be able to put it into terms of number of shares increasing, but you can't know the value of those shares. What am I missing?
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Re: When do you see effects of compound interest on net worth?

Post by Bacchus01 »

masonstone wrote: Fri Sep 27, 2019 8:14 pm At what multiple of net worth do you feel that compound interest adds to annual net worth increase more than income?
This is a great question and one that comes up here often.

While the bull market has given high confidence and high returns, even then the growth and dividends do not outweigh my continued contributions. And our portfolio is more than $3M.

I always say, if you want to focus on growing the largest possible NW, either for early retirement or other things, focus on your career first. That’s the biggest investment most of us will ever make and is generally the number one factor for wealth accumulation.

That’s also why the boglehead way of simple, low cost, broad based indexes is great. You don’t have to spend any time on the portfolio and can spend all your time on your career (all your investment time, that is)
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Re: When do you see effects of compound interest on net worth?

Post by Bacchus01 »

snackdog wrote: Sat Sep 28, 2019 7:26 am Many of you have yet to see your investment losses exceed your income. That's when you know you have some interesting savings.
I’ve had swings of more than $150k in a given month. And no, that’s not more than my income, but that’s because I focused on my income.
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Re: When do you see effects of compound interest on net worth?

Post by dbr »

snackdog wrote: Sat Sep 28, 2019 7:26 am Many of you have yet to see your investment losses exceed your income. That's when you know you have some interesting savings.
That would be the test I would vote for.
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Re: When do you see effects of compound interest on net worth?

Post by HomeStretch »

At ~ 10x. At that point with a good or bad year of market returns, you can see returns (positive or negative) equal to your employment income.
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Re: When do you see effects of compound interest on net worth?

Post by Shallowpockets »

Dude2 wrote: Sat Sep 28, 2019 7:40 am If you are talking about fixed income, then, ok, let's talk math, no problem. What I don't comprehend is how people apply the concept of compound interest to their stock holdings. There are no guarantees of value with stocks. You may be able to put it into terms of number of shares increasing, but you can't know the value of those shares. What am I missing?
The above is a point that seems to have eluded the majority of replies. Compound interest, not gains on your stock portfolio. You would need interest or paid out distributions to figure your compounding. If stock portfolio goes up simply due to stock prices going up, there is not any compounding involved.
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Re: When do you see effects of compound interest on net worth?

Post by meowcat »

Dude2 wrote: Sat Sep 28, 2019 7:40 am If you are talking about fixed income, then, ok, let's talk math, no problem. What I don't comprehend is how people apply the concept of compound interest to their stock holdings. There are no guarantees of value with stocks. You may be able to put it into terms of number of shares increasing, but you can't know the value of those shares. What am I missing?
Replace compound "interest" with compound "return".
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Re: When do you see affects of net worth?

Post by stoptothink »

Kenkat wrote: Fri Sep 27, 2019 8:27 pm About 10x sounds right to me.
We're currently at about 15x, but we have very low household expenditures compared to most on this board. Most of our net worth (retirements assets and home equity) has been accumulated in the last 7yrs, and (back of napkin math) suggests ~85% of it was contributions on our end. Hopefully that number drops dramatically as we continue.
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Re: When do you see effects of compound interest on net worth?

Post by dbr »

Dude2 wrote: Sat Sep 28, 2019 7:40 am If you are talking about fixed income, then, ok, let's talk math, no problem. What I don't comprehend is how people apply the concept of compound interest to their stock holdings. There are no guarantees of value with stocks. You may be able to put it into terms of number of shares increasing, but you can't know the value of those shares. What am I missing?
Compounding is a mathematical model in which the return in any period applies to the accumulated results of previous periods, including all previously applied returns. As another poster pointed out the mistake is in using the word interest for stocks when the applicable term is return. Note return also applies to bonds and to cash, as bonds have both interest and NAV changes and for cash the return is just the interest paid. The compounding model does assume the return/interest is reinvested when received, but the model can be extended to include withdrawals. Withdrawals can happen if interest or dividends are paid and not reinvested or if shares are sold and the cash taken out. The general result computed for any investment is the compound (average) annual growth rate (CAGR) which applies to any investment. One can also compute arithmetic average returns, time weighted return, dollar weighted return, and internal rate of return, all over multiple periods of time, with or without withdrawals.
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Re: When do you see effects of compound interest on net worth?

Post by willthrill81 »

As others have noted, it's only when your investments are several multiples of your annual expenses that the effects of compounding (at 'reasonable' rates of return at least) become meaningful. Before this level is reached, contributions to one's investments have a far bigger effect than do returns.

It is for this reason that the returns of the final decade or so of accumulation is so important to most accumulators. This is because this is when they have the most invested in the market

For instance, investors with $400k in their portfolio who also contributed $20k a year from 1990-1999 ended with $1.9 million (nominal). But if we move the period forward ten years to 2000-2009, the ending balance was $800k, less than half as much. And from 2010 until now, they would have ended up with $1.2 million.

As a result of this, sequence of returns risk is greater for those with a low savings rate because they are more dependent on portfolio returns.
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Re: When do you see effects of compound interest on net worth?

Post by Lee_WSP »

CAGR is probably the correct term, so going off of that, the math is easy.

Portfolio = yearly contribution / CAGR

Input say 4 or 5% for CAGR and you can solve for portfolio. Take that and you can compare to net worth, but net worth includes house and cars and personal belongings, so I don't really feel like net worth is a great metric. I think liquid net worth is more salient.

To get a percentage answer you can use this equation

Portfolio = savings percentage/ CAGR

So if we go with 5% CAGR and 20% savings rate, the multiple is x 4x. If 40% savings rate, the multiple is 8x
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