Follow my pattern 1, 2, 3, …..what will be next?

Mentally our minds calculate numbers in sequential order and we like to extrapolate using the same pattern.  An example of this is simple arithmetic could be 10, 20, 30 …. the next number most would guess would be 40.

The issue with investing in a lot of cases is that the investment markets don’t necessarily move in sequential orders – thus creating complexities for our normal lateral day-to-day thinking. The other issue is with the compounding of an investment return, in that numbers also don’t move in sequential order.

A classic example of this problem is as illustrated below:

The above calculator assumes that if you invested $100k and this capital grew at 10% in value each year that the investment would be worth around $732k million in 20 years time.

The interesting thing with this mathematical calculation, is that it has taken 16 years to reach $500k.  However between years 16 and 20 the capital value increases from $500k to $732k in just 4 years!

The problem in understanding compounding interest is in sequential calculations.  When the above investor started out they began with $100k and in the 1st year in the above example they made $10k in earnings. In the second year they made $11k. What happens then is the investor then extrapolates this data out in the sequential ordering of adding around $10k per year (give or take a couple of dollars either side).  With this thinking, it would mean that they would have accumulated $200k in just over 20 years (which is $10k times 20 years plus the original capital of $100k) giving a total investment amount of $300k.

This is obviously in start contrast to the actual final result in the above example.

So when analysing patterns and sequential mathematics, investors can quickly get very frustrated as they are not seeing the immediate results from the capital. However I believe with compounding interest it certainly has its benefits it just may take some time to see it and then, like a rocket, it just takes off!