Compounding: Perfect In Every Way

Mary Poppins is one of those Disney movies that I vaguely remember watching as a child.  It wasn’t one of my favorites, but I probably watched it a dozen times.  The movie was revisited in a sequel of sorts as “Mary Poppins Returns” this month and I had the opportunity to watch it on a sick day with my daughter.

In the original rendition Mr. Banks works, wait for it, at The Bank. I don’t recall ever having any personal financial takeaways like I would like to share. (Spoiler Alert below)

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2019’s edition opens with a caption announcing its setting in a dreary time; likely around the turn of the 20th century and viewers are treated to a visit from the bank’s solicitors (lawyers).  A notice of repossession is posted on the front door that gives the Banks family five days to pay the loan off in its entirety.

We learn that Michael Banks, who after the unfortunate passing of his wife, is now a parent to three children of his own.  He has taken a loan from his employer with the home on Cherry Tree Lane as collateral and hasn’t made a payment in three months.

Mr. Banks is an artist and had to take a job as a teller at the bank to make ends meet.  The Banks family most likely did not have life insurance.  This isn’t an I told you so moment, because it’s not, as my daughter would say, kind.

However, with young children in the picture and the certainty of an artist’s or an independent contractor’s salary at risk having life insurance should’ve practically been mandatory.  Life insurance would’ve allowed for the day-to-day financial activities of the family to continue.

This post’s real supercalifragilisticexpialidocious topic is about how the Banks save the house on Cherry Tree Lane.  In the 1964 version, we’re introduced to tuppence which means two pence (two pennies) or hardly worth the metal it’s minted with.

Michael wants to use his tuppence to feed the birds.  His father has other plans and decides to introduce him to the benefits of saving his money with a trip to the bank.  The bankers’ melodically serenade young Michael with a handful of reasons for him to entrust them with his tuppence.  The financially inspired lyrics are below and the scene is worth rewatching with an eye towards wealth building.

If you invest your tuppence wisely in the bank safe and sound soon that tuppence safely invested in the bank will COMPOUND!  And you’ll achieve that sense of conquest as you affluence expands in the hands of the directors who invest as propriety demands.

Tuppence, patiently, cautiously trustingly invested in the, to be specific…Fidelity Fiduciary Bank!

bank_peopleAlthough the lyrics are dripping with 19th and 20th century trust department walnut wood paneled walls and marble Michael isn’t impressed. After drama ensues, Mr. Banks eventually deposits the tuppence at the bank.

Leaping 30-40 years into the future, about the time from when a person graduate’s college to when they retire, we learn that Michael’s tuppence was invested in shares in The Bank and that the organization did quite well.  The value of the shares is enough to pay off the loan on their home and the reason is the annual compounding of returns.

How could compounding provide the adequate value to pay the lien on the Banks home?  It doesn’t seem…possible.  In an epic post, Morgan Housel writes,

There are over 2,000 books picking apart how Warren Buffett built his fortune. But none are called “This Guy Has Been Investing Consistently for Three-Quarters of a Century.” But we know that’s the key to the majority of his success; it’s just hard to wrap your head around that math because it’s not intuitive. There are books on economic cycles, trading strategies, and sector bets. But the most powerful and important book should be called “Shut Up And Wait.” (Emphasis Mine)

We learn from Morgan that, “underappreciating the power of compounding, driven by the tendency to intuitively think about exponential growth in linear terms,” is a source of poor investment results.

It’s one of the short-comings of our human ape/caveman brain to fail to understand the effects of compounding when it comes to anything from habits which results compound over time such as eating, exercising, or investing.  We don’t comprehend or appreciate the importance of the compounding, cascading, snowball of microcosmic actions on the big picture.

How can investors more intuitively understand compounding so that they can use it to their advantage?  This is especially important for saving for goals decades into the future like retirement.  Josh Brown relays a story in his “Double Your Money” post about the invention of chess that illustrates the concept.  Here is a video illustration of grains of rice compounding on a chess board from investor Mohnish Pabrai.

After describing the drawdowns following the Great Financial Crisis Josh writes that,

And still, during this period investors who woke up, went to work, played with their kids and left their contributed cash in their investment accounts had the ability to earn 150% by doing absolutely nothing. If they had diligently contributed during the 2008-2009 maelstrom, they had that much more to let the miracle of compounding practice its magic upon.

They doubled their money and then some.

Formulating an investment plan and sticking with it is not easy.  Investors wishing to build wealth to meet their goals require the fortitude and discipline necessary to invest month-in-and-month-out over decades like taking your daily medicine regiment.  Time for meeting long-term goals is on our side.  Compounding is the perfect boost which affords investors the opportunity to meet their goals.  It is the spoonful of sugar that helps the medicine go down.

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