This is going back to the basics 101.
All of us are aware why compounding is one of the wonders of the world.
By now, most investors would have known the effect of compounding over time and how they can exponentially grow their wealth to incredible amount, if done correctly.
Compounding returns which are positive year after year feels great, especially in an environment where the market allows us to do so. But too often we get attached to statistics and numbers and thereafter starts to erode our euphoric emotions that allow us to somewhat extrapolate the same returns over the next 40 years. Is that realistic?
This is exactly how insurance agent attempts to sell product because it just looks too attractive 40 years down the road and often folks fell for such thing.
Dark Side Of Negative Compounding
The dark side of compounding is often neglected as folks tend to focus towards the part on success and brushed aside the part on failure.
Negative compounding - a reversal concept of the dark evil side of compounding.
This type of compounding can play a big part in slowing down and to a large extent destroy our attempt to grow our wealth.
Credit card charges is one of most immediate example I can think of that applies in our daily lives.
While there are benefits associated with it, it charges exorbitant interest rates for folks who fail to pay the charges on time. The interest amount may be minuscule and ridiculed at the beginning but over time it can add up to quite a substantial amount.
The same goes for folks who invest in the stock market thinking they can earn a decent 3 - 4% over the next 40 years.
The truth is there are many who lost money in the stock market and erode their wealth over time. To put it simply, these group of people are probably not ready and would be better off growing their wealth via other means.
The next time you get excited over compounding, think of what it can do on the reverse. Beware on the dark side of compounding.