The way I explained it to him was:
Interest is something applied to loans/bonds, whereas when you invest you have a stake in the appreciation and/or growth of what you invested in. I said already these two things are not the same.
Now the way I understand it, your earnings in the stock market may have a compounding effect but it does not make it compound interest.
Notable differences in my opinion:
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Usually interest from banks is guaranteed. There is a compounding period and accrual periods. Stocks do not have accrual periods because nothing is being added except for value (which rises and falls). Dividends do not count as accrual because it not being added to the principal and is instead paid to the investor. You can reinvest the dividend money but it may have a separate rate of return now (you may have bought lower or higher) which will affect your overall average rate of return.
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Any return on your investment is based on the averages of what you spent to acquire it. Whereas using compound interest adds the return to your principal and then based on the compounding period gives you an earning based on your new principal.
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One makes you a stakeholder, the other does not.
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Volatility, stocks have it, money sitting in a bank does not. What you still have is risk, especially if you are lending the money for interest. (Someone could default on the loan)
This is an example I used.
You have 1000 dollars.
A) you deposit into a bank which pays you 10% annual interest ( accrues daily, compounds monthly). At the end of the year you have 1105 dollars.
B) you invest in stock xyz and it does not pay dividends. After the price volatility throughout the year, your return is 10% and you walk away with 1100 dollars.
I think 3 and 4 were briefly touched upon in #1. Does anyone see a flaw in my logic? If I am thinking about this the wrong way could you kindly explain how? Otherwise can you explain a good way for me to show the difference.
Tldr: there is a difference between compound interest and investing in stocks/etfs/indexes. If you agree please explain how I can explain it to my friend, if you disagree please explain how I am wrong.
Edit: some typos
Edit2: Conclusion so far I have come to based on some of the comments.
They are the same if some factors align.
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If the stock pays dividends and you reinvest those dividends.
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You compound the interest annually at the same time that you calculate the return for a stock that pays no dividends ( or pays dividends that you choose not to reinvest )
Which leads me to think that if you have to create these scenarios to make them be the same, then they are not. Aside from the fact that they fundamentally are different things.
Edit 3: I see the flaw in my thinking that dividends had any effect on whether or not a stock compounds. As some fellow redditors have clarified a "stock is always compounding in that the return of one period always affects the return of the next."
Edit 4: Some people are confusing accrual/compounding with compounding interest/interest on interest.
Edit 5: So many people on reddit are ready to jump in and say they are the same thing. They are not, and to say that investment in equities are the same as the type of growth one would get from an equal return from a savings account is a misrepresentation of the volatility of the stock market and an assumption that the board was always green when it was not. How many people here have weak hands and would sell at a downward trend, the hypocrisy is unbelievable.
Submitted April 06, 2019 at 09:05PM by elAxxar http://bit.ly/2UDgen9
