Albert Einstein famously referred to compound interest as the ‘eighth wonder of the world’. What did one of the greatest minds of the 20th century mean by this statement?
From a mathematical perspective, compound interest represents the ‘eighth wonder of the world’ because it generates exponential vs. linear returns. Basically, returns are amplified over the long term by receiving returns on returns (interest on interest).
This same concept can be applied to investing in general (real estate, stocks, etc.). Although investing in stocks doesn’t technically represent compound interest, investors maintain the ability to earn compound returns by reinvesting returns from dividends and staying invested over the long term.
This week’s chart is a fantastic depiction of the power of staying invested over the long term. It shows the return of investing $1 in the S&P 500 in January 1901 ($1 invested in 1901 would be worth ~ $100,000 today). I also thought it was a timely reminder given the recent victory of Donald Trump and the Republican sweep of the House and the Senate in the U.S.
The chart goes all the way back to the presidential term of the first Roosevelt (Theodore or Teddy) and shows Democratic presidents in blue while Republican presidential terms are represented in red.
Some readers may find it interesting that the stock market (S&P 500) has performed better, on average, during Democratic presidential terms rather than Republican – the average annual return during
Democrat presidential terms has been 12.3% vs. 7.8% for Republican presidential terms. Keen observers will notice two periods of significant market underperformance being the 1929 crash and the 2008 global financial crisis which both occurred during Republican presidencies.
If we excluded those two periods (correlation doesn’t necessary imply causation), the returns between Democratic and Republican presidents would likely be much closer.
The overarching message from the chart is investors should maintain focus on staying invested for the long term and benefitting from compound returns rather than attempting to ‘time’ their investments based on who is occupying the White House. This doesn’t mean there aren’t different strategies or sectors to consider based on who controls the political landscape, it just means that investors with a longer-term perspective are more likely to benefit from the ‘eighth wonder of the world.’
Eric Van Enk is a wealth adviser & associate portfolio manager with National Bank Financial in Medicine Hat. He is a graduate of the University of Calgary, as well as a CFA charter holder with 20 years of financial markets experience in New York, Toronto and Calgary. He can be reached at eric.vanenk@nbc.ca
