The Point of Growth

There comes a time in investing when growth exceeds contributions. This is the point where I become pretty darn excited! Sure, early on you can have a couple of odd years when growth jumps up but that’s not what I’m talking about. More than likely, those jumps will be followed by declines that make you second guess your investments. It’s about more consistency in your account growth that exceeds your contributions that I try to stay focused on. Of course, you’re going to have those years where its less or even (dare I say it?) negative. But on average each year should get better and better.

That’s the beauty of exponential growth. It’s a snowball rolling uphill… with your investment account getting larger each year by larger growth each year. This can be inspiring to those just starting out. Just think about when, in the future, your account will grow each year by more than you’ve added. When does the account double in growth compared to my contributions? When will it triple? That’s when you see real progress in your accounts.

What does it look like

To demonstrate my point, below I show a hypothetical account with contributions of $5,000 each year growing or earning 8% each year for a 22 year old. After 13 years the account is worth over $111k! Only $65k was contributed. In the next year, $5,000 will be contributed but the account will have growth of $9k… almost double the contribution!

I removed the ending balance data to highlight the growth line year over year. Notice the lines are smooth with no inconsistencies.

That pretty exciting! You can probably look at the chart and predict the year when growth will be triple the contribution amount of $5,000! It’s year 19 when our 22 year old turns 40.

Theory doesn’t reflect real world returns

Unfortunately, that’s theory. It doesn’t actually work that way because we’re thinking of a pure linear model. Straight lines or perfectly curved lines don’t actually happen in real life investing. Each year the market performs differently. Some years are up, some are down, some are relatively flat. There is no certain way to predict exactly how the market will perform from one year to the next. The fluctuations each year is called volatility. If you’re going to invest then there is going to be volatility in your investment account. One year may go down in value despite your contributions to the account and the next year it may rebound to a new account high. You just never know.

To illustrate the point, I’ll use the Vanguard Total Stock Market Index (VTSAX) as a proxy for investing in the stock market over the past 13 years. Why thirteen? Because that was the point in time in my hypo model above that earnings or growth nearly doubled the annual contributions of $5,000 based on an 8% return.

In the chart above, I use the past 13 full calendar years for returns (2006 – 2018). You can see the earnings are both up and down from year to year. There’s volatility from year to year with no consistent returns. Yet, the balance, as demonstrated from the red line, displays a resemblance of the account balance line in the hypothetical model above.

In the chart below, the volatility of the returns is really highlighted by the yellow line compared to the consistent grey line of even $5,000 contributions each year (I’ve removed the account balance data). That’s the real world. The growth doesn’t consistently happen at a predictable rate. It fluctuates from one year to the next.

Hypo vs Real World

What’s interesting is when we compare the hypo model to the real-world results for VTSAX.  When compared, it’s interesting to see that despite the market volatility from year to year of VTSAX, the overall direction of the account balances largely mirrors the hypo account balance*. Some of the years there is underperformance against the hypo and some years there is outperformance. It tends to even out over longer periods of time. During shorter intervals (years in this case) the returns are inconsistent, they’re all over the place. The hypo model provides for a consistent 8% return year in and year out.

What can you do

No one can predict the future. We rely on linear thinking to point us in the direction we would like to go with investing. While I would like to average an 8% return on my investments from year to year and I create models to project that outcome, I really have no clue as to how the market will perform next year or the year after. However, my experience over the last 25+ years tells me that directionally, I’m going the right way. When I invest, I invest for the long term with the hope that over long periods of time, the short term volatility is smoothed out over longer periods of time.

In my first post, Closing in and Looking Back, I included a chart that displayed the growth of our replacement income to assets over our accumulation years. That chart follows our asset growth over that period of time. If you look back at the chart, you’ll see that it resembles exponential growth of our accounts over time. There is a curve to it that confirms our accounts were accumulating at a growing rate despite that fact that our contributions were relatively flat from one year to the next.

You can’t control the returns of the market. The market will return what it returns. You can control your contributions. Consistently saving is the key to long term results. Resolve to set aside a certain amount each month or every paycheck. Better yet, make your savings a percentage of your pay so when you receive a raise or promotion, your savings automatically increase as well. Make it a habit that eventually you don’t even think about.

It doesn’t happen overnight. It took a decade or more for us and probably will take that long for you. But when it happens, when that point of growth exceeds your contributions from year to year, watch out…that’s when the magic of compounding really takes over.

Have your investment accounts risen to the point of growth above contributions? When do you predict growth will take over? Share your thoughts below in the comments.

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*Note: The similarities of the account balance of my hypothetical model compared to VTSAX was not expected when writing this post and the results are extremely coincidental. In no way should you think that VTSAX will over the long term perform similar to an average 8% return. Results will absolutely deviate!


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