Albert Einstein allegedly once described compounding as the eighth wonder of the world and one of the most powerful forces in the universe. Compounding – when your returns from the previous period are added onto the next period (and again and again) – is indeed a powerful force and a crucial part of long-term investing. While many can grasp the maths behind compounding, it is very hard to visualize over the long-term as the numbers become so large.
To benefit from compounding, investors must remain invested. If you invest £1,000 on day one and see a 10% annual return, in 12 months you will have £1,100 invested. If you experience the same 10% gain next year, your investments will be worth £1,210 at the end of year two. If you were prescient enough to have invested $100,000 in the S&P 500 at the beginning of 1993, you would have about $2 million at the end of 2023. This is a return on investment of 1895%, or 10.1% per year.
This year, the S&P 500 continued to hit record highs, driven by a small number of technology-focused companies in the US benefiting from swirling euphoria over artificial intelligence (AI). The exponential growth these companies have experienced is remarkable—chipmaker Nvidia accounted for 35% of the S&P 500’s total returns in the first half of the year. While it is not uncommon for a few stocks to dominate leadership in an index and make up a significant portion of an index’s returns, Nvidia and Microsoft’s impact on the S&P this year is extraordinary.
Although the focus this year has been on a few stocks, we advise investors to think more carefully about the importance of buying stocks with a proven track record of compounding earnings over time. The focus on a few large technology companies means these compounding stocks have actually become cheaper on a valuation basis. When equity market rallies broaden out to include other sectors and geographies, as opposed to just US mega technology companies, we could then see renewed interest for these quality compounders. Over time, this should drive their stock prices higher.
Conducting thorough research, being comfortable with occasionally missing out and avoiding over-diversification across every sub-sector or market are the cornerstones of our approach.
We minimise unnecessary trading and have adopted a long-term, disciplined approach, as we believe this will help provide the best risk-adjusted returns over the long-term.
Rather than simply investing in an index, we focus on a smaller number of high-quality companies with long-term compounding characteristics. This allows us to benefit from compounding and experience growth potential, as both the initial principal and accumulated interest - from the dividend or the company keeping its cashflows to re-invest at high internal rates of return - allow the investment to grow and increase wealth over time.
This communication is provided for information purposes only. The information presented herein provides a general update on market conditions and is not intended and should not be construed as an offer, invitation, solicitation or recommendation to buy or sell any specific investment or participate in any investment (or other) strategy. The subject of the communication is not a regulated investment. Past performance is not an indication of future performance and the value of investments and the income derived from them may fluctuate and you may not receive back the amount you originally invest. Although this document has been prepared on the basis of information we believe to be reliable, LGT Wealth Management UK LLP gives no representation or warranty in relation to the accuracy or completeness of the information presented herein. The information presented herein does not provide sufficient information on which to make an informed investment decision. No liability is accepted whatsoever by LGT Wealth Management UK LLP, employees and associated companies for any direct or consequential loss arising from this document.
LGT Wealth Management UK LLP is authorised and regulated by the Financial Conduct Authority in the United Kingdom.
