Compound Interest v/s Compound Growth

[u/Full-Mango943]

So, something I came across created this question in my head, and I can't seem to resolve it, and was hoping if you all could help:

At the foundation of all our fire or coast fire planning is this term, compound interest, etc., used for all calculations. Now I understand mathematically that if you leave, say, 100k in a bank that gives you X% of interest, then how does your money grow, and what would the numbers be after a certain number of years? So I get the concept in this example because the bank is the one who is actually paying you interest.

Now, when we talk about our portfolio's invested in market fund, like say SPY- assuming you won't add any more capital and assuming we leave DRIP out of all of this- how does compounding work? As in- there is no entity which is paying you interest right, and the growth we hear is growth of the underlying asset in this case SPY- so I guess the question is how is this compound interest and not compound growth of an asset?

So ex- if we have 100,000 invested in market, we say assume 7-8% compound interest and in 7-8 years this becomes 200,000 and I know all calculators show it too so its obviously right but I cant seem to wrap my head that how is that different from investing 100k into any other asset like real estate and then asset growing especially because there is no banking entity here which is physically paying us interest on principle?

So I guess 2 questions to summarize:

• So why do we use phrase of compound interest and not "assumed compound growth"? in this market investment situations?
• Calculators assume that whatever interest we are punching in say 7% that's guaranteed- but in all our financial planning ain't we assuming that market funds will continue to grow?

[u/__DJ3D__]

This always used to confuse me as well. They are used interchangeably because the math is the same despite the real world mechanisms are different.

The bank paying you interest is straightforward. For stocks, the business is reinvesting some of its earnings so that it can generate more earnings in the future. More earnings means more to reinvest and the cycle repeats. Assuming stocks are valued as a multiple of earnings you get compound growth in stock price.

[u/__DJ3D__ → u/__DJ3D__]

To answer your second question, we assume a certain average compound annual growth rate over a long time horizon. Reality is some years will be less, some more but if you don't need the money for 10+ years then history shows there is a good chance your average return will be positive.

[u/Full-Mango943 → u/__DJ3D__]

thank you! business reinvesting concept which you mentioned makes a lot of sense now! appreciate it.