Back to the Basics: Compound Interest Explained (The Snowball That Makes You Rich)

0:00So a couple of episodes ago, we started going way back to the beginning again and started talking about just the very basics of what it takes to get started in the stock market and we talked about everything from just what is a stock to what is dilution of the stock and what are the shares of this and so today we're going to talk about one of my favorite things about stock investing and i know or investing in general i know it's andrew's absolute favorite thing it's everybody's favorite thing and that is compound interest this show is sponsored by liquid iv now that the weather is finally heating up.

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2:57You're tuned in to the Investing for Beginners podcast. Investing for Beginners podcast. The show for the long-term investor. We cut through the noise to focus on what works. compounding discipline and the conviction to buy wonderful businesses and stick with them your path to financial freedom start now welcome back to investing for beginners everybody my name is steven morris he is the amazing the ever investing the never um i'm gonna stop yeah that's okay you can start i hit a wall anyway so he is andrew say there and today we are talking about one of the most awesome topics to talk about and we could probably spend hours talking about how awesome it is and never get tired of it and that is compound interest and andrew before we started the recording today i i just wanted to know and i so i went in to the calculator later and I wanted to know if I so if since you're I'm older than you so at 20 years old and for the record I am not 20 years older than Andrew it's just I'm doing it that way because I'm older than him so Andrew at 20 years old starts investing a hundred dollars a month Stephen at 40 years old So same time as Andrew starts investing$1 ,000 a month.

4:25And I wanted to know which one comes out ahead at the end. So Andrew gets to invest for 40 years. Steven gets to invest for 20 years. And so I wanted to know who came out ahead. Who do you think came out ahead, Andrew? Well, I think that's obvious. So it's the 20 year by a very, very tiny margin. Okay. So I was totally surprised too, and I did it multiple times just to check. So you're 20 year at$1 ,000 a month at an average of an 11 % return with 3 % inflation accounted for. You're looking at$1 ,000 ,001 ,000. Okay. at 40 years you're looking at 999 800 dollars that's great yeah that is um that's good that that gives hope for all of us right that so we don't need to wait 40 years right so you can still like everybody that's like oh i waited too long proof no you didn't right what's crazy though about this whole thing is amount of money invested.

5:47Even though you were investing$100 a month, you still invested a quarter, literally, of what I did at$1 ,000. Interesting. It is crazy the amount of money that you ultimately make slash save compared to what I have to do just to keep up with you. Right, right. so there's there's two winners in the story yeah it's crazy man and the the the reason i bring all of this up is because compound interest is just that freaking amazing and i i wish and for the youtube i'll make sure to add the chart so that um you guys can see the curve because i'm telling you andrew that curve like when it takes off like it's like an f-16 man like i don't know how much you know about airplanes but an f-16 or an f-15 they're they're one of the few aircraft in the world that can go straight or from the ground to a straight vertical and climb not many aircraft can do that um and that's literally what it looks like with compound interest like it's like and you're just like whoa it's so cool man so so let's get into it and i'll stop being such a a goofy nerd um just explain for us what compound track compound interest is yeah albert einstein the nerdiest of nerds called it the eighth wonder of the world and it really is for all the reasons you described, you can really make a lot with a little.

7:31And the reason why it works is because it's interest on interest on interest. So the first time you get interest, you're like, okay, that was not really worth it. But each time, if you keep reinvesting that interest, the returns, you're getting a greater and greater amount. And so we continue using it. I like the F15, f-16 thing that's that's a that's a new one um should patent that but uh t-shirt yeah i like it uh the the one image that lots of people use that also describes as the snowball rolling down the hill and as it gets bigger it accumulates more and more and then you chart it out and it's yeah exponential so um it's very very powerful and it is the sweet the sweet sauce in the stock market especially if you're getting dividends and that's where i get really excited about compound interest right and so we'll get back to the dividends or we'll get to that next because i definitely want to talk about that but as far as your snowball analogy um or the snowball analogy that you were just talking about.

8:47One of the things I think, I think you're on AAR talking to Evan. I don't remember where I heard you talking about it. Or maybe I heard Evan talking about it. I don't remember. I heard one of you two talking about it. And you said one of the craziest things that you didn't realize initially about compound interest is the bigger it gets, the less snow it takes. My brain must be, my brain must be a little empty today. It might have not been you. i i don't i have i it was you were evan but basically the the the idea is like when you start forming the the snowball like it takes all the snow to just get the snowball started but as as you continue to roll it just very little snow is getting added to it but it's still expanding at a much bigger rate because the radius is so much bigger right right so it's taking less snow to grow exponentially larger basically so um and that is such a powerful thought that i never had of it before but it's absolutely right because if you think about it like your initial snowball is the size of your hands right so your diameter is a lot smaller but once you get a big diameter it's taking very little snow comparatively to just grow massive and that is just so freaking cool dude yeah it really is and like you can check the math on it too and see that this isn't one of our like half-baked analogies that we like to use this is like an actual real one and it's it's true it's it's it's truly incredible so the the next thing that i wanted to bring up actually you know what no no we'll go back to your dividends thing i wanted to talk about that later but you already brought it up so we'll we'll hit that one um well why are dividends so key into your compound interest thesis

10:59because uh like i was saying about the way the interest makes more interest um it kind of just puts a little bit more of the control of the compounding on your side um one way i like to look at it and this might not be the best idea because it's not super realistic but let's say we had a hundred dollar stock and it was paying a$2 dividend. Like, okay, whoop-de-doo, it's paying two bucks. Like nobody cares, right? Compared to what you had to put in, that doesn't feel like anything. But if you're reinvesting that money, and let's say that the stock that you buy becomes a hundred bagger, it goes up 100X.

11:44So your$100 goes up 100X. Your$2 that you reinvested will also go up 100x. So what's 100 times two, we're at 200. How much did you put in 100? So that one little dividend that we didn't even think about becomes bigger than how much you had even put in. And yeah, not every stock goes 100 bagger. It's actually pretty rare, but the math still maths at a smaller amount. Like for a stock to 10x over a very long time might not be the craziest idea in the world. If you're in the S &P 500 and you're doing an index, if you're in there long enough, you'll get a 10X on that money. So the dividends, they all create huge potential.

12:27They're like this huge future potential that if you just reinvest it, add it to the snowball, it becomes its own takeoff point. And that's exciting to me. Yeah, it's almost like you're just adding another snowball. is almost free money. I mean, I kind of hesitate to call it free money, because it's not free money, but it kind of feels like it is. At least to me, it does. So the next thing I wanted you to talk about, Andrew, and we say it all the time, and I think this is a great opportunity to really define it and hammer it home for anyone listening right now that is like, I wanna invest, I wanna invest, but I don't have the money.

13:21Or I don't feel confident or whatever you're, I don't wanna, I'm gonna call it an excuse, but I don't mean it offensive like that. Like, well, it's just, I don't know what a better word to use. Whatever your excuse is for not investing, this is why you need to have that time in the market i feel like your example at the very top of the episode really described it well like you don't need a lot of money to turn something into a million dollars you know it is just the f-15 going to work um and i was joking with my wife the other day because i have an old recliner i'm trying to sell on facebook marketplace so like i watched the youtube video you know this guy was like had all the secrets to making all this money on facebook marketplace right and just my my recliner was just sitting there on facebook marketplace and i was like i was like why is it so hard to make easy money like why can't i just make easy money like this guy on youtube on my recliner and she goes well your your your stock market is kind of easy money and and it kind of is right like we don't have to do a lot of work But you do have to do the upfront work of putting that money in and saving it and then letting it compound on its own.

14:44So it's super powerful, but it's not intuitive. It goes against our emotions and our biases. We like to think that you just hustle and you grind and you do a bunch of work and that's how you're going to make money. and that's 100 true in capitalism but when it comes to investments it's a completely different ball game and actually the people who do less and just let the compounding happen end up making more a lot of the time so it's a super ethereal uh counterintuitive counterintuitive just weird phenomenon but once you can grasp it you realize oh i don't need to have a ton of money and i don't like one more thing i'll say like you don't have to even be a great stock picker like how many stories are there people who just happen to put a little bit of money in the tesla or happen to put a little bit of money into nvidia we we don't know in advance which what the next home run stocks are going to be.

15:54But if you just start putting money to work, your chances get better and better that you're going to find something great. And it doesn't need to be like the next NVIDIA or Tesla either. Like my very first stock pick, the very first stock I bought was in 2012. I remember because it was Thanksgiving. I just drove like eight hours from SoCal to San Francisco area with like a newborn and cranky newborn. That was fun. But I remember on my iOS 3 or whatever it was, looking at the stocks app, and I bought$27 of Microsoft stock. That's now$300, which, okay, it's not life-changing. But the concept is that I didn't know anything about the stock market.

16:44I just picked a really well known company and I didn't know what I was doing. And it made a 10 bagger. So like, where else can you do that other than the stock market? You can just buy these stocks and sure. You might not get Warren Buffett like returns because you're not as experienced as Warren Buffett, but you can still compound some serious money just by putting yourself out there and putting some money to work. And it's like you've said it before, you know, what other place in the world can you have no experience, no formal education, no anything, and still have just as much of a chance of being successful as me, you, Buffett, anybody.

17:31You have that same chance and you don't need anything. You need a smartphone and an app. That's it. And a little bit of cash. and you know i tell people you know that i talk to just out in life but when i talk to him about it you know i was talking to the guy that was doing my taxes yesterday you know i asked him like you know what do you invest in and he was like well i can tell you right now i don't like investing in individual stocks i'm like let's talk about that

18:06and it's like bro i don't i don't five dollars i don't care just you know pick a dollar amount five bucks ten bucks i promise you do it you build the discipline long enough and that's the cool thing about that i didn't calculate into that initial your that 20 year old investment is you're not going to do a hundred dollars a month the rest of your life like it might go down a couple years chances are it's probably gonna go up and stay up a lot more because you get promotions you move up in your career like you get married maybe your wife starts contributing to it like there are a whole lot of things that can increase that hundred dollars to to that thousand dollars mark and so now you're just totally crushing me and it's that time in market.

18:58It's so, so freaking important, man.

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22:10The first stock is NVIDIA. And the second stock is the company that I just made a large position for my portfolio available only for subscribers to value spotlight. I reveal that stock pick in a deep dive research report in a generational moment, reigniting human connections through a tangible network of intangible assets, which you can access at einvestingforbeginners.com slash reignite. The next one I want to talk about is the rule of 72. Are you familiar? Do you want to break it down? I can. Yeah, I love it. All right. So the rule of 72 is basically the, it's a, it's not, it's a theory. It's not, it's not like factual math.

22:51So like, don't think this is going to tell you exactly what you're going to have. But the basic rule is you take whatever the average rate of return is. so we'll i'm just going to use the s p 500 which is 11 or 10 to 11 we'll we'll do it easy math we'll say 10 and so you'll you'll divide that 10 by 72 and that gives you i'm sorry you'll divide 72 by 10 and that gives you how long it's going to take for your money to double so if you're expecting a rate of return like you make an investment and you're saying okay i should make 13 on this investment you divide um 72 by 13 and that is how long it's going to take your money to double so off the 10 that i used it's going to take 7.2 years for our money to double so So and again, like that's pretty crazy thinking that, you know, I put$100 someplace and I don't touch it.

24:02And then in seven years, it's going to be$200. Again, not life changing money. I get that. But like Andrew was talking about a little bit earlier, once you like start getting that interest on interest on interest on interest, that's when that rule of 72 really starts to kick in. and you're starting to that's when the f-15 is going straight up vertical and you're getting you know that that two hundred thousand dollars doubling and that is freaking insanity dude that is mind-blowing and i hate math and i hate that i get excited about math but that math gets me excited hey you add money in the equation that makes a lot more fun right right but i mean did i break that down right did i miss anything on that yeah so i think you'll like this uh one time i was on the walk with my wife and i was thinking about the rule of 72 and uh i was like doing math on like what if you did the rule of 72 like four times so it's like uh you said 7.2 years at 10 percent so seven you take seven years seven years seven years seven years you have to remember that this stuff doubles right so if we had a thousand dollars if it doubled it's at two thousand but then it would double again so that's not another thousand that's two thousand and then the four thousand double again that becomes eight thousand so like you can you can really get to a lot because it all multiplies on itself and i like what you said earlier about like these little mini snowballs and that's that's the power is each of the stocks that we're putting into the stock market there's these businesses behind it and if you think about like again you did the math on uh like a per month basis so those are like each each little deposits like its own little snowball some of those will grow faster than others some of them won't grow as fast but um when you start learning about like the power laws and like how just some companies are just so extraordinary and like the companies we invest in they're compounding too and that's that's an exciting thought of you know a company that like microsoft would go back to them because it's easier to understand And Microsoft was everywhere with Windows and everything.

26:36And they were just gushing in cash. And so what were they doing? They were making their own little snowballs. And one of those snowballs just happened to be Microsoft Azure, right? You take Google, same thing. They're like, you know, we just have billions of dollars. Let's just throw two and a half billion at YouTube. Now look at YouTube. If YouTube was its own company, it would be one of the bigger companies in the S &P 500. So the snowballs, we're having snowballs on snowballs on snowballs. Have you seen Inception? No. No? They're like, I don't want to spoil it, but it's like dreams on dreams.

27:13So that's what we're talking here. We're talking snowballs on snowballs. And that's exciting too. And when you're invested in the right businesses, the right companies with like really talented people, people like the Elon Musks of the world or the Warren Buffetts of the world, or these just really smart people who know how to make a lot of money in business. We get to just tag along and invest with them. And to your point, there's no bar. We don't have to pass a test. We don't have to be accepted or they don't have to think I'm cool. It's open territory and we can all come in and we get into that nightclub and it's fun.

27:56and we didn't have any other entry ticket other than the cash we put in that's ours that we're investing so it really is a fun thing and yeah i guess it's not something that most people are running around getting all excited about but we'll do that here because it is a great opportunity i mean and i think people should be running around getting excited about it because you know i whether you're the 20 year old andrew or the 40 year old steven that's still life-changing money and maybe you're the 40 year old steven and you can't afford um the the thousand dollars and maybe you can only afford the the hundred dollars you know that that's still a decent chunk in 20 years yeah the the you wouldn't have had otherwise and so it's the concept of you know would you rather me give you 20 now or a hundred dollars in a month like give me the hundred and i mean it's just i i think people should be getting excited about it which kind of leads me to into a question i'm really curious about is when when did you learn about compound interest and how long did it take for it to like sink in like holy crap this is really cool was it instant no it was not instant um this podcast the blog we have that's been this forced work i put on myself those have been the learning moments so it was april of 2013 was when i started writing about compound interest and it was in the act of writing when i realized oh like you kind of always know the math right but like if i'm gonna write something put it down to paper and other people are gonna read it i'd rather have some accurate numbers and then you you like do the charts and you see the visuals and it's like wow okay this is this is legit you know uh what about you um i was i want to say mid-20s um and i was actually listening to the dave ramsey show and he was explaining compound interest and i remember sitting there thinking like this old fool like he forgot how to do math like that's not how math works and i remember going home and getting a texas instruments calculator out of my kitchen drawer and i sat down with that and a piece of paper and actually like okay so and i i did it i didn't do it the correct way like with the formula i just like okay so i'm gonna have um a hundred dollars this month i get no interest so next month i'll have a hundred dollars and i'll get this much interest and i don't remember but i'm pretty sure i was stupid and i didn't factor in the fact that that interest is over a year not a month so i'm pretty sure i was like way off um which is funny considering i'm like dave rames he's an idiot but i remember sitting there like just with my paper and calculator i'm like holy crap like this actually works like this is a real thing and then my next question is why didn't i learn this in school why why did i learn all these calculus crap that i've never used since but i did not learn about compound interest and maybe i did and i just forgot because i was a dumb kid but i don't remember ever getting taught about compound interest and that was my next question And so that's why I love the fact like we have this platform where we can scream compound interest from the rooftops and anyone willing to listen can hear it because I feel like it is probably the least known to most important thing in the world.

32:11Yeah. And as much like technology has come in and made investing easier, the bar is so easy now to get started. when you started investing did you actually have to call it in like what was it like i don't no no i i had to pay 4.95 and that was like a good deal 4.95 per trade and like you couldn't buy partial shares and um because so this was like the beginning of the value spotlight newsletter and you know people who subscribe or have listened to us for a while know like that portfolio has 150 a month that goes in so because i couldn't buy partial shares if i wanted to buy something sometimes i would have to wait a month to to buy it so like i would write about the stock and then write about it again and then it's like okay we're buying two months worth of this stock because it's like a 300 stock and you gotta wait till we get 300 um yeah Yeah.

33:17And so now it's like, it's insane. You can, like you're saying, download an app, pick a reputable broker that is recommended by somebody you trust and like connecting bank accounts. That was, that was a process too. Now there's all these fintechs that just make everything like, and now we're so spoiled. It's like, well, of course it should be this way, you know and like because i i've opened i've pro i'm probably the youngest that's open like on a i have the youngest brokerage account we'll say of of the everybody in the company um literally connecting my bank account was would you like to connect your bank account yes pick your bank usaa like scan your face scan to my face so you know to unlock it and then it's like usaa say do you give permission yes your bank account's connected would you like the deposit yes how much that was literally and it took like 60 seconds to go through this whole like literally and it's like so so easy it's no effort at all and that's why like i don't know when like apps started becoming a thing for the stock market like i know like in the days of like jordan belfoy like the wolf on wall street or wolf of wall street days like they had to actually call it in which that blows my mind how in the heck did that work like that's crazy um so that that's dinosaur stone age stuff man like that's nuts but i think it's it's there's literally no excuse anymore like we everybody just about everybody has a smartphone phone i'm about to take my dad's away because i'm about he gets an old flip phone but um but uh you know my dad bless his heart i'm tired of being tech support yeah drives me nuts but um but no it's it's it's so easy and if you haven't started yet i implore you to to really look at it and make sure you're making the right decision for you.

35:39And I'm sure there are times in life when it isn't the right time for you, and that's fine. No shame. But also, I would strongly recommend to know exactly when the right time is so that you're not missing out on that time in market because it's that important. Yeah, it really is. um and oh go ahead no go ahead i was gonna say like when it comes to your investing experience uh is there what what's the one thing you regret about it so i think my answer to this might not be what you think um i wish i wasn't so scared to take on risk really yeah yeah you're right didn't see that coming yeah um like not now like obviously i've got people who who follow and like they're they know i'm like the risk averse person so that's always in consideration but when i was starting out like what do you got to lose you I don't know why I clung on so tightly to this$500 that's in the stock market.

37:01And maybe that's just a natural progression. When you're a beginner, you just feel more risk averse. But I got to get over it. But just looking at Facebook and Netflix and Google and Amazon and all those stocks, I could have just thrown a little bit in there just to see what happens. you know but i was like no i'm i'm very you know i'm gonna be risk averse um it was a different time back then like um well you're just coming off of um one of the worst market downturns we had in several decades so i mean that kind of makes sense that you would you would have a little bit of that uneasy feeling, I guess.

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40:12Right. They used to say like value investing, if you had just been a value investor, like that was the big thing when I started. And now it's like, if you're a value investor, what a dork. Like, what's he doing? What's he doing? Not throwing his intelligent investor book into the garbage, you know, like. what a weirdo so like uh i don't know i don't know what i'm saying anymore this is just my story i love it i mean and for me i think i wasted a lot of time like i knew i should be investing i knew i should be like figuring stuff out but i was just lazy and didn't want to you know i just waited way too long to start and not having respect and then so when i did start investing not having respect for what the market actually is um because i was like you know what i went in with the attitude almost the exact opposite of you because like i said i started day trading initially and i'm like i'm gonna lose money i'm just here to learn anyway so i don't even care And the money I allocated to put in the market, I allocated it as a loss.