Most people understand how compounding works in theory. But actually witnessing how much it can grow your wealth is a completely different story. And it’s only possible for people willing to do something counterintuitive for years to come before it starts to bear fruit.
The math behind compounding is straightforward. The behavior to get it to work for you is not.
The Real Variable Isn't the Return Rate
While the return is the factor that most people can focus on in growing wealth, it is not the variable that separates the wealthy from the non-wealthy investor. The primary variable that determines an investor’s outcome is consistency.
The investment return you get to keep by avoiding interruption to compounding may exceed the additional return you might get from investing in another product. Therefore, staying with your plan, through the inevitable downturns, by continuing to invest when the market is volatile, and by resisting temptation to sell out to chase a better performing investment – these are the disciplines that are far more important than trying to get the very highest return in compounding.
Interruption by you kills compounding. Every time you withdraw from the market you are starting again from the beginning with the new base that the compounding has to work with.
The Behaviors That Break the Chain
It's tempting to wait for a 'perfect' time to invest. Markets can look volatile from the outside, and that perception is often what keeps people waiting.. But the investors that have gained wealth through investing over a period of 20 to 30 years are not people that tried to time the markets to invest at the ‘perfect’ time. Instead, they have simply got into the market and stayed in the market and let the power of compounding do the hard work for them. This is how compounding works - in the long run, time in the market has historically produced a better return for investors than trying to time the market.
Cringing in fear when there is a decline in the market and sell your investments at the low point. If one is a long-term investor, it is imperative that you realize that the declines in the market can be temporary. There will be ups and downs in the stock market and the number that tracks your investments will go up and down. But, if you are a long term investor, remember that it is your job to ignore the declines and to remain in the markets to allow your investments to appreciate in value. You will make mistakes along the way and attempt to avoid pain and lock in a loss that will only serve to guarantee that you will experience more pain in the long run. The long term investor is aware of the compounding that is going on in the portfolio and it is the long term investor that remains in the markets during the decline, while others are pulling their money out of the market in a frantic attempt to cut and run and save their investments.
Not managing a portfolio on an ongoing basis, whereby the investment in the portfolio changes in value, with certain investments in the portfolio deteriorating in quality over time including those that cease to meet your objectives with the investment in the portfolio. Allowing a portfolio to depreciate in value over time with large, non-performing fees charged while the quality of the investments within the portfolio deteriorates is particularly harmful. Although less obvious to deter than waiting to invest or attempting to time the markets, such a strategy can result in substantial damage to your long-term returns. While the large ongoing fees will certainly reduce returns for the investor, it is the failure to allow compounding to continue to reward the discipline of on-going investment in the portfolio that will have the greatest negative impact on the return to the investor. A quality investment portfolio is one that is managed on an on-going basis where efforts are made to keep all of the quality holdings in the portfolio and to allow the resulting returns from all of the investments in the portfolio to compound over time.
Why This Is Harder for Halal Investors — and How to Fix It
For Halal investors, it’s an additional layer of behavioral bias friction. It’s not enough to have confidence that what you invested in was Halal at the point of investment. You need to have confidence that it remains Halal over time. When that confidence is lost, there is a strong temptation to withdraw from the investment altogether and go on cash until you work out what to do with your money. This pause in investment can be fatal to your long term growth in your investment journey as it is a classic example of a behavior bias which has a huge impact on compounding of your wealth over time.
It is not an attempt to change human nature to become more of a disciplined person overnight and put more wealth at risk than needed. Simply invest consistently by automating your contributions and rebalancing your portfolio. Keep the on-going monitoring and tracking of your halal and ethical compliance in the background to automatically flag any non-Shariah-compliance. You should not have to keep reminding yourself about it. In this way, your wealth construction can function better without depending on your human willpower each week.
The less you rely on willpower for your wealth-building, the better your investments may compound over time.
Consistency Is a System, Not a Personality Trait
Compounding returns to earn returns on returns to returns are not built by financially smart or for that matter by the more emotionally disciplined people. Most have simply set up a system to invest and left it to compound while they go about their lives.
A “system” for compounding returns to earn returns on returns to other returns will look very different from person to person. For example, some individuals may take advantage of monthly, incremental investments to reach financial goals, while others will create a core investment portfolio that immediately and automatically begins to work to diversify funds and rebalance as necessary. Most likely, it will be a hybrid, with a core portfolio being the largest portion of one’s investments and, as already mentioned, also setting up a system of incremental investments on a monthly basis.
You don’t have to get everything right. Your job is to create as few exit points for yourself as possible. Places where your natural disposition to run for the exits in the face of friction, uncertainty or noise takes hold and you abandon ship in the short term.
You don’t have to be an expert to benefit from long-term investing. For many investors, consistency over time has historically mattered more than sophistication.
If You're Still Building That System
Our Ready-Made Halal Portfolios are designed with the behavioral and financial aspects of long-term investing. In it, the decisions that most investors either get wrong or fail to make are taken care of automatically i.e. rebalancing, Shariah compliance monitoring etc. Purification of income is tracked in detail and updated instantly.
All you have to do is fund it and then leave it alone. The rest of the system will keep working for you.
For more information on Musaffa’s Ready-Made Halal Portfolios, please visit www.musaffa.com and review our Wrap Fee Brochure
Disclaimer: The content is for educational purposes only and is not a substitute for personalized advice from Musaffa. It does not constitute fatwa, legal, or tax advice, an offer, or a solicitation to buy or sell any security or investment strategy. The information is believed reliable as of publication date but may not reflect recent changes, and Musaffa does not guarantee its accuracy, completeness, or timeliness. Musaffa's Shariah compliance screening is based on AAOIFI Shariah standards. Any methodologies or assessments presented are for informational purposes only and should not be relied upon as the sole basis for any investment decision. It is important to conduct your own research or consult with a financial advisor or tax professional before making any investment decisions. All investments involve risk, and the value of securities and other investments may fluctuate due to market conditions, economic factors, or other external influences. Content may include historical or hypothetical data. Past performance is not indicative of future results. The views expressed are those of certain Musaffa personnel as of the publication date, are for informational purposes only, and may change without notice. They may differ from views of other areas of the firm, and any forward-looking statements are not guarantees and may not come to pass. Logos, brand names and external links are used for identification only and do not imply endorsement. For additional information and statements, see our disclaimers: https://musaffa.com/disclaimer
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