• Compound interest is often referred to as the “eighth wonder of the world”.
• A quote attributed to Albert Einstein states "He who understands it, earns it; he who doesn't, pays it"
• While all of us intuitively understand it and endeavor to earn it, its power can still surprise.
• This is particularly true as time periods lengthen, where a seemingly small difference in returns can have a huge dollar impact.
• One of the most effective ways to earn compounded returns is through long-term ownership in high quality companies, and in Canada those that continue to grow their dividends have proven to be compounding champions.
• The real magic happens when we can link portfolio performance to the success of a financial plan, an essential tool in charting your path forward. We are at the ready to engage with clients on this topic.

Compound interest is a key to long-term investing success…

While the provenance of the quote remains in dispute, some suggest no less than Albert Einstein regarded compound interest as the eighth wonder of the world. The quote further goes on to state that "He who understands it, earns it; he who doesn't, pays it". Indeed we would hazard to guess that the reason many of us became interested in investing was that initial lesson in the power of compounding returns over time – the way the numbers stack up can almost seem like magic.

… but so is time

We recently read an article about the success Warren Buffett has had as an investor and the author made an interesting point. While his long term investment record has been superb, many have posted better returns. The difference is they haven’t posted better returns for well in excess of 50 years, like the Oracle of Omaha has! The key to earning eye-popping sums from compounded returns isn’t a function of just the return itself but importantly it is also a function of time.

The power of compounding with Canadian dividend paying stocks

Dividend growth stocks continue to compound at a healthy rate

We have used the chart above many times over the years to demonstrate the power of focusing Canadian holdings on dividend paying and growing stocks to compound capital over time. We have been following this data for over a decade, and with every update we are surprised at the progress made. This chart also serves another purpose in that it shows just how much small differences in return are amplified with the application of a significant time period.

Small differences in return can have a huge impact…

The data series in this chart starts 39 years ago, in October, 1986 – one year before the big crash in 1987. If one were casually discussing returns and thought about the difference between the 11.1% long-term compounded return of dividend growers versus the 9.5% return for dividend payers, it might be notable but doesn’t seem like a huge difference. If we start with the $1000 depicted at the beginning of this graph, after 5 years the dividend growers portfolio has about $136 more. A decent amount off a $1000 base but not an amount that will change anyone’s life. The results on the right hand side of the chart show what 39 years of compounded growth looks like an the results are somewhat astounding. A 1.6% higher annual rate of return results in a near-doubling of the end-value. Never mind that the dividend growers portfolio grows to nearly 4.5x the amount of the benchmark TSX Composite!

… but we need to give portfolios the time needed

When markets are jubilant and speculation starts to take hold, time horizons tend to shorten. The same thing happens when we see the other side of the coin and fear becomes the dominant emotion. Giving in to either of these temptations are often kryptonite for long-term returns. Speculation tends to result in risk-taking that can do damage forward looking return prospects, while moving to be more defensive during market panic attacks has the same results. In order for the power of compounding to work, time is an essential element. This is one area where individual investors have a significant advantage over institutions and their huge research departments and trading operations. Those investors are evaluated on strict timelines that can compress to monthly or less. That doesn’t apply to someone who is managing to a long-term goal who is only accountable to themselves. So long as we use long timelines to our advantage we stand a strong chance of earning the returns that are essential to a successful financial plan as compounding works its magic.

The Harbour Group

416-842-2300

Putting you first, every time, to help you navigate the complexities of managing your wealth. All of our team members, all of our resources, all of our collective insight: ALL FOR ONE: YOU™.

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