Compound interest or market bubble

Being in a place of lean FIRE at age 28 I often think about giving up nursing and pursuing passion projects and local traveling. Like most people in my position, I have some doubts about having enough to retire. There is a lot of fear around quitting your job due to running out of money. People are really good at planting doubt in your mind at a time when you are already scared and nervous about giving up your job. The fire movement is relatively new and abnormal to most people so of course that creates a level of fear around the subject.

One of the biggest arguments I hear against the viability of FIRE is that markets are at an all time high and therefore, in a market bubble. Markets are supposed to reach new all time highs as that’s how markets work. But, could simple compound interest explain the market?

My friend had a look at the graph of the S&P 500 below and said I’m not putting my money in the stock market it looks like a bubble to me. The “bubble” is actually the result of consistent exponential growth i.e. compounded interest growth.  It can be modelled by the same math that depicts bacteria cultures etc.

IMG_1878

Note that plotting 9.5% returns over the past 90 years gives the same looking “bubble” as noted in the graphs above with the blue and tan lines. On a logarithmic scale, we actually have a very consistent growth. There’s always up and down years, but 7% after inflation is actually a very conservative “average”. The power of compounding interest explains why the S&P 500 continues to reach new all time highs and will continue to do so in the future.

This subject can certainly get more technical (we could use P/E ratios etc)  but keeping it simple, the power compounding explains the current markets conditions adequately enough to squash any self doubts about running out of money.

Happy friday and don’t worry so much

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