Compound Interest Is Real Modern-Day Alchemy

Dividend growth investing enables a compounding of investment returns that is nearly certain to build wealth over the long run. This is particularly true when investors have a long time horizon.

Someone’s sitting in the shade today because someone planted a tree a long time ago.
Warren Buffett

Surprisingly, this is similar to medieval alchemy. Alchemy was the early field of science where experimentalists toiled to turn base metals such as iron and lead into precious gold – a much more valuable substance.

Compounding is modern day alchemy.

What is alchemy?

Alchemy was the pseudoscience centered around the creation of a philosopher’s stone.

Although one had never been discovered or created, a philosopher’s stone was believed to hold the power to change base metals (like iron and lead) into precious metals – most often gold.

Medieval alchemists have long been ridiculed. With today’s knowledge of science and technology, a simple look at the periodic table tells us that there is no way to turn base metals into gold. They are different substances, after all.

However, this does not mean that the alchemists lacked intelligence. Johns Hopkins University’s Lawrence Principe described medieval alchemists as “amazingly good experimentalists,” saying:

Any modern professor of chemistry today would be more than happy to hire some of these guys as lab techs.

Now that a historical background has been established, the similarities and differences between compounding and alchemy will be discussed in detail.

Similarities and differences between compounding and alchemy

Despite seeming quite different on the surface, the main goal of alchemy and compounding is the same: to multiply wealth over time.

Unlike alchemy, compounding is a notably powerful force. Many people have commented on its surprising capability to build wealth, including one of the brightest minds ever – Albert Einstein.

Consider the following quote.

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.
– Source disputed, often attributed to Albert Einstein

Compounding often occurs when investors purchase shares of high-quality dividend growth stocks such as:

Historically, these companies have delivered outsized returns to their shareholders, above the market’s long-term average of 8-10%. This has multiplied wealth over time – similar to alchemy.

An 8% rate of return does not seem to “multiply” wealth on the surface. This amount to earning $8 for every $100 invested – which does not come close to multiplying wealth by even 2x.

The real multiplication begins when this 8% return is compounded over long periods of time.

The following diagram represents the growth of $1,000 compounded over 40 years at an 8% and 10% rate of return.

Growth of $1,000 Over 40 Years[ Enlarge Image ]

Please note that the above diagram is a simplification. In reality, stock market returns experience a certain degree of volatility, resulting in a graph that is more “lumpy” than the one shown above.

The time period in the above graph was chosen for a reason. Forty years represents the approximate length of an average working career.

This means that if an investor can invest $1,000 from their first few paychecks in the workforce, this early money will grow to be approximately $22,000 at an 8% rate of return and approximately $45,000 at a 10% rate of return after 40 years of compounding.

Moreover, this represents a multiplication of 22x and 45x the initial capital investment. Clearly, compounding has the same wealth-multiplying capabilities that alchemists sought from the philosopher’s stone in medieval times.

Compounding and alchemy are also similar in the sense that they are systemic in nature.

Alchemists followed experimental procedures with the goal of creating the first philosopher’s stone. These procedures were likely repeatable, with a step-by-step process documented in laboratory notebooks.

Compounding is similar. Investment returns are maximized when investors stick to a long-term systematic plan. Following a predetermined investment strategy helps minimize the psychological errors inherent in behavioral finance.

The best types of systematic investing systems are based on quantitative characteristics that either increase returns or reduce risk (or both!). At Sure Dividend, that plan comes from The 8 Rules of Dividend Investing which are used to rank stocks with 25 or more years of steady or rising dividends – including the Dividend Aristocrats.

Systematic investing comes in all shapes and sizes. A few other examples are:

  • The Sure Retirement strategy, which applies the 8 Rules to companies with 5% or higher dividend yields.
  • The Coffee Can Portfolio, which advocates for buying high-quality stocks and holding them forever.

The systematic nature of alchemy and investing is the second similarity I wanted to highlight in this article.

Compounding and alchemy also have one major difference. As per Mr. Principe’s quote above, alchemists were generally quite intelligent. This Johns Hopkins University historian stated that medieval alchemists would make great laboratory technicians under modern professors of chemistry.

Unlike alchemy, it does not require a great deal of intelligence to take advantage of the magical power of compounding.

“You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.”
Warren Buffett (Trades, Portfolio)

Moreover, mistakes are common in investing. I make mistakes. Warren Buffett makes mistakes. Every investor does.

“In this business, if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.”
– Peter Lynch

Mistakes are a natural part of the investment process. This does not mean that you are a bad investor. It also does not mean that you lack the “intelligence” required for investing.

At its heart, investing is actually quite simple – and certainly much less complex than experimental alchemy.

Final thoughts

Alchemy is a medieval pseudo-science based on a phenomenon that we now know is false.

Compounding is an observable effect in the financial markets that will continue to generate wealth for decades to come.

On the surface, they could not be more different. However, each has the same goal – to increase the practitioner’s wealth with very little input. They are also both very systematic in nature, with an alchemist’s laboratory notebook comparable to a systematic investment strategy.

In that sense, compounding is equivalent to modern day alchemy because it allows investors to multiply their wealth in the long run.

Disclosure: I am not long any of the stocks mentioned in this article.

Photo: Grow Your Money – (CC BY 2.0)

Free "dummies guide" to trading options

Did you know trading options can actually be safer and more profitable than buying and selling stocks? Video and plain English training guide reveals how to get started tonight. 100% free.

Download now.

You May Also Like

About the Author: GuruFocus