10 Important Statistics in Long-Term Investing and the Power of Compound Interest

Inflation, Spending, and Production All Heading Toward Recession - May Summary

The April PCE report confirms the US is on the brink of recession as in yesterday's GDP report, with inflation still high while spending, income, and savings continue to plummet. Meanwhile, Chicago PMI unexpectedly dropped much more than expected, raising concerns about an imminent recession, pulling SPX sharply down to 5200 before finding support. In this video, Steve will also review some important trades in May and the most basic rules for evaluating a sell options strategy.

Throughout more than 120 years of history, the stock market has always been considered the weather vane of the global economy. It not only reflects important events but also shows the general sentiment of investors. Despite going through many short-term decline phases, the stock market still affirms a common trend: stocks are the best long-term investment channel. Therefore, seeking sustainable growth businesses and stocks is always the top goal of smart investors.

At the same time, investors can leverage the power of compound interest to maximize their returns. Understanding and applying compound interest will significantly increase investment assets over time.

This week's article from Viet Hustler will bring you interesting perspectives on the stock market, statistics long-term investing and stock investing, and why investors should leverage compound interest to maximize their assets.

Part I: Stocks and the Long-Term Investing Story

1. The 120-Year Journey of Dow Jones and the General Trend of the Stock Market

As one of the oldest and most famous indices, the Dow Jones Industrial Average (DJIA) has reflected the economy throughout major global events on the US stock market.

• Since its formation in May 1896 to now, DJIA has increased by more than 50,000% .

Some notable crisis and recovery periods:

• 1898: Spanish-American War.

• 1914-1918: World War I.

• 1929-1954: Stock Market Crash (Great Depression) in 1929 leading to a long recovery period lasting 25 years.

  • 1939-1945: World War II.

• 1962: Cuban Missile Crisis.

• 2000-2007: Irrational exuberance about Dot-com bubble and the crises after the bubble burst, recovery lasting 6 years.

  • FYI: Dow Jones plummeted nearly 30% in September 2001.

• 2001: The 9/11 Event.

→ However, the 120-year Dow Jones chart shows a general trend:

Despite economic and political crises leading to recovery periods that can last up to decades, the stock market continues its long-term upward trend thanks to human development.

• Historical bull and bear market phases:

2. In the long run, stocks remain the best investment

Starting from USD 1 from 1800, the nominal total amount received by 2006 for the following investment items:

• Stocks: ~12.7 million USD.

• Bonds: ~18,235 USD.

• Treasury bills (Bills): 5,061 USD.

• Gold: ~32.84 USD.

• Consumer Price Index (CPI): ~16.84 USD.

Thus, a clear trend can be seen:

• Stocks are the form of investment with the highest long-term return rate, although the risk level of stocks is higher than other assets.

  • …followed by bonds and treasury bills.

3. Psychology (of investors) in short-term market cycles

• Investor psychology in a market cycle (Psychology of a Market Cycle) => shows the short-term reaction of investors to economic events.

• Market psychology always repeats in the following cycle:

  • Take off (Takeoff): Price starts to rise slightly. → Investors cautiously observe.

  • First Sell Off (First Sell-Off): After reaching a certain level, a mild sell-off occurs. → Some investors take profits, make short-term adjustments.

  • Bear Trap: Price continues to rise after the first sell-off. → Belief that the uptrend continues, investors confident and optimistic.

  • Media Attention (Media Attention): Strong price increase attracts media. → Investors become excited.

  • Enthusiasm (Enthusiasm): Herd effect appears, attracting more investors. → Greed psychology begins to appear.

  • Greed (Greed): Excessive optimism pushes market value far beyond intrinsic value.

  • Delusion (Delusion): The “this time it's different” mentality appears, believing the market won't fall, creating a false sense of security.

  • New Paradigm (New Paradigm): Investors absolutely believe in the strong uptrend.

  • Denial (Denial): Price starts to fall, investors refuse to accept it, believing price will rise again.

  • Bull Trap: Price rises slightly but it's just a trap for investors due to false optimism in the market.

  • Fear (Fear): Price drops sharply, fear psychology emerges.

  • Capitulation (Capitulation): Panic, accept panic selling to cut losses.

  • Despair (Despair): Price hits bottom, investors' confidence completely destroyed.

  • Return to the Mean (Return to the Mean): Price gradually recovers to the long-term average trend (dashed gray line) ~~ confidence gradually recovers but still cautious.

    FYI: No matter how strongly it rises or falls in the short term, stocks always oscillate around the long-term average trend (mean reversion).

4. Signs of market euphoria and extremes

1. Signs of overheated market

• Large number of IPOs.

• Prices rising rapidly.

• Excessive use of financial leverage.

• Easy credit.

• High trading volume.

• P/E and EV/EBITDA at historical highs.

• Boom in art and luxury goods.

• Everyone talking about finance.

• Mindset of “this time it's different”, expecting new highs.

• Amateur investors willing to sell assets to buy stocks.

• New product innovation leading to excessive euphoria

  • … like the internet in the 2000s (Dot-com Bubble) or recently AI.

• Prolonged herd mentality

  • …causing stock prices to far exceed intrinsic value.

2. Signs of market bottoming

• No M&A deals.

• No IPOs.

• Venture capital funds have no new investment capital.

• P/S, P/E and EV/EBITDA very low.

• Many companies trading below book value.

• Central bank implements easing policy for 6 - 12 months.

• Previously favored sectors are shunned.

• Only those with high credit scores get loans.

• Investors become cautious and exit the market.

• Negative consumer sentiment.

• Looking back at the 10 largest M&A deals of all time:

5. Revenue growth is the main driver pushing stock prices in the long term

• According to 1-year, 3-year, 5-year, and 10-year milestones from 1990 - 2009, the factors contributing to total returns of the top-quartile group in S&P 500 show a common trend:

Revenue growth is the most important factor in generating long-term shareholder total returns.

6. Companies with high ROIC will perform better over time

During the period from 1999 to 2015:

• Companies in the top 25% with the highest ROIC: cumulative performance continuously increases, exceeding 120% in 2015.

• Companies in the top 25% with the lowest ROIC: cumulative performance drops below -60% in 2015.

Thus:

Return on Invested Capital (ROIC) is an important factor in evaluating a company's long-term performance.

Companies with high ROIC will generate more profit from invested capital than most other companies, thereby delivering higher returns to shareholders in the long term.

Long-term performance comparison: Apple and Domino's Pizza.

• Apple: growth nearly +2,500% from 2009-2020.

  • … thanks to continuous improvements in technology products like iPhone, iPad, and Apple Watch.

• Domino's Pizza: up more than +6,500% same period.

  • Starting from 1 store in 1960, Domino's Pizza now has 17,000 stores worldwide, thanks to the development of a fast delivery system and sustainable business strategy.

→ Domino's Pizza, although not a large technology company like Apple, can still be an excellent long-term investment thanks to its stable and sustainable growth.

Part II: Compound Interest - “The 8th Wonder of the World”

1. The power of compound interest in driving growth rates

Genius Albert Einstein called compound interest the “8th Wonder of the World” due to its power.

Simply put:

• Compound interest (compounding interest) is the interest generated added to the principal to continue a new interest cycle.

• This cycle repeats throughout the investment period.

• The more new interest is added to the principal, repeating cycles cause assets to grow stronger in later cycles.

The power of compound interest: If you double 0.01 USD every day for 30 days, you will have 5,368,709.12 USD!

2. Time market participation greatly affects the power of compound interest

With a sufficiently large annual compound interest rate (e.g., 8% below): investing early is more beneficial than “investing more”.

• Investor 1 (blue) invests from age 25, only invests 5,000 USD over 10 years until age 34. No further investments thereafter.

• Investor 2 (orange) invests from age 35, invests 5,000 USD continuously over 3 years.

• By age 65, Investor 1's accumulation reaches 787K USD, still higher than Investor 2 (661K USD), even though only invested in the first 10 years!

  • …thanks to starting earlier.

Time in the market greatly affects the power of compound interest.

Starting to invest as early as possible will be a huge advantage that helps young people outperform even financial experts.

• Of course, this is only true with sufficiently high returns / interest rates: for example, with bond interest rates ~5%, this is not entirely true.

  • But anyway, investing only in the first 10 years and getting 80% of the amount compared to someone investing 30 years later is still much more advantageous!

    

3. Compound interest accelerates the power of dividend reinvestment

• Assume, the same investment 50,000 USD, annual growth rate 8%;

  • Investor A (orange) uses dividends for spending

    → Assets after 40 years reach ~1 million USD.

  • Investor B (blue) reinvests dividends (continues using dividends to buy more shares, assuming the company pays 3.33% dividend)

    → Assets after 40 years reach more than 3 million USD!

Investors who reinvest dividends will significantly increase annual returns and total assets in the future.

4. Why is the first 100,000 USD milestone important?

At the Berkshire Hathaway shareholder meeting in the 1990s, a young man asked Charlie Munger, former vice chairman of Berkshire Hathaway, for advice on how to become rich:

Why is accumulating the first 100,000 USD important?

• Assume you can save 10,000 USD/year at 7%/year interest rate.

→ Thus, it takes 7.84 years to reach the first 100,000 USD, and it is also the longest period.

• Not only due to the long time period, accumulating 100,000 USD also requires strictly increasing income and reducing expenses (such as diversifying income sources, cutting non-essential expenses, etc.)

From 100,000 USD, the power of compound interest begins to increase significantly

• Assuming saving continues to be maintained:

  • From $100K to $200K: takes 5.1 years.

  • From $200K to $300K: takes 3.78 years.

  • …

  • From $900K to $1M: only takes 1.35 years!

In summary:

• Financial foundation: The first 100,000 USD can be seen as an important milestone in building a personal financial foundation.

  After achieving this amount, investing and asset growth will become easier thanks to compound interest and better investment opportunities.

• Compound interest: Once the initial amount is accumulated, compound interest will help assets grow quickly, making the saving and investing process less difficult.

CONCLUSION

In reality, no one can guarantee a certain interest rate when investing, but the stock market has proven its good performance since its inception. To optimize the power of "compound interest" and "time", investors need to be persistent, consistent and principled, as well as carefully select suitable investment channels to optimize the interest rate.

Although the miracle of compound interest is mentioned a lot in financial literature, it is essentially just a normal mathematical formula, no more, no less. By starting early and following some basic investment principles, investors can get closer to building a wealthy future for themselves.