• Ryan Himes

Cumulative Returns > Compound Returns

Long term investing for the win, obviously. But why? It's easy to say, it's even easier to invest for the long term than it is the short term... but why is it better? Well the answer is cumulative returns. Cumulative refers to the total percentage return over a number of years. Whereas compound returns refer to earning a percentage each year and allowing each year's percentage gain to add, combine, or compound, onto the previous years' returns. And these are simply two different ways of calculating returns, so obviously there are situations where these two calculations will equal each other. For instance, earning 10% each year for 5 years is equal to a cumulative return of 61.1%.

The reason why long term investing wins is because most of the time, an investment's yearly returns are varying. Very few investments can promise exactly 10% yearly (if you find one hmu) so LT investors focus less on the yearly return and focus more on the cumulative return over the entire life of the investment. For instance, Netflix from 2010-2020 had 8 years of positive gains, some as high as 300% and some as low as -60%. And if an investor analyzed the stock within a 1 year time-frame, they might've looked at a stock that unperformed the market at times and decided to sell. Well that would've been a ridiculously stupid decision because Netflix was the best performing stock of the decade, reaching over 4000% cumulative return between 2010-2020 (the S&P return during the same period was 189%).

Investors that stuck to their guns, saw the bigger picture, and invested for the long term, won. And it shouldn't be that surprising, because short term investing is incredibly challenging and the returns require continuous compounding in order to make significant amounts of money. And continuous compounding means that each day, each hour, needs a positive return from an investment. And over time, it's highly unlikely that a short-term investor makes more money than a long term investor. It vastly more probable that a short-term investor loses money; 75% of day traders go bankrupt. The median return of a day trader for 2018 was -36.75%.

The famous anecdote is Warren Buffett's challenge to hedge fund managers on Wall Street. He challenged the best money managers in the world to outperform the S&P 500 over a ten year period. The average return of the S&P over the period was 9.1% per year, whereas the hedge fund managers posted a meager 4.3% per year. Not even half. And those are supposedly the best of the best.

And they are: trust me the last thing I'll do is shit on the best money managers in the world. Would you believe me if I told you that it wasn't their abilities that caused them to fail, it was their methods of investing. And that is what Warren Buffett saw when he made the bet. They were the best in the world, playing the short game rather than the long game, and they got crushed. So if that's how the best in the world performs with this strategy, how do you think you'll do?

Investment philosophy matters more than the investments you make. If you remember that, and you always keep your eye on the bigger picture, then it's nearly impossible to break rule #1.