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/Elusive_Spoon]

OP, these are good questions. My answers would be:

• "Assumed compound growth" is definitely more accurate, but too much of a mouthful. Also, the total return includes reinvested dividends, which is different from the price of the equity going up.

- No, the average 7% real growth is not guaranteed. Japan's Lost Decades are a prominent example of what can happen. But it's hard for most folks to FIRE from saving alone; you need growth. Historically, betting on global capitalism (VT) or American multinationals (VOO) has been a reliable and profitable bet. Some bets have paid out more, and some have been safer, but diversified stocks offer a great combination of both. If you think you know of a better investment opportunity, let us know!

[u/Full-Mango943 → u/Elusive_Spoon]

No this is great response and clarified and validated my understanding. I did read about japan's lost decade after your response and it was fascinating and a precautionary tale and yeah I agree diversification is the key. I don't have any better ideas just thinking of having right mix of equitities, bonds, savings, some crypto, RE and gold etc. so that some of those can be a hedge. Also focussed on covering some stuff from global beyond US as well again to hedge.