Most people looking to make money from the stock market will go in search of that one magic stock. That one stock that will make them rich overnight without the risk. But for any rational person, they know that this is not possible. More money has been lost in ‘magic stocks’ than at the point of a gun. Just look at the story of GTAT investors. Whilst the majority look for that magic stock, it is far more prudent and wise to use a different method to build wealth via investing. A method that you can control. Albert Einstein even called it the 8th wonder of the world. I’m talking about time and the power of compounding returns.
Warren Buffet, the greatest investor the world has ever seen, has used the principle of time and compounding returns to become a billionaire. Starting early is the greatest gift you can give yourself. If you start early and if you invest efficiently you can let your money work hard for you and reap the reward produced by compounding interest. Buffet knew at an early age that the secret of investing is to start early and this led him to buy his first stock at 11. Even then, he jokes that he started too late.
Compounding Interest – The Greatest Way to Build Wealth
Compounding Returns (or Compounded interest( might sound like a complicated process but it is really simple.
If you invest £100 and you get a return or interest rate of £10%, after one year, you will have made a profit of £10 and your total money would now be worth £110.
In the second year, if you take take that £110 and once again invest it at 10%, you will have made a profit id £11 in the year and your money would now be worth £121.
In the third year, by investing the £121 at 10%, you will make a profit of £12.10 and your money will have now turned into £133.10.
As you can see, your money grows disproportionally due the power of compound interest. It doesn’t take long for the snowball effect to take place. Have a look at what £100 invested at 10% would be worth after the following years :
- 5 years = £161.05
- 10 years = £259.37
- 15 years = £417.72
- 20 years = £672.74
- 30 years = £1,744.94
- 40 years = £4,525.92
- 50 years = £11,739.08
- 80 years = £204,840.02
- 100 years = £1,378,061.23
Some of the lengthier periods above might look dramatically unrealistic but it just goes to show the power of keeping your money in the market for long. Someone who starts investing at 20 and lives to 70 will have money compounding in the markets for 50 years. The returns they would get for every £100 invested is phenomenal – over 10,000%!
Time in the market is the most important thing.
Time is an investors greatest friend. As seen from the above, compounding returns can do wonders and make your portfolio grow exponentially. The longer you stay invested in the market, the greater the probability of you getting positive returns. Just look at the image below produces by Hargreaves Lansdown. It illustrates the returns from the FTSE All Share Index, with dividends reinvested, over various timeframes over the last 30 years on a rolling one-month basis
The study conducted by Hargreaves Lansdown shows that by increasing your time horizon, you increase the chances of making a profit from your investment decisions. Longer time horizons leads to an increased success rate because a longer timeframe can dampen the effect of the inevitable short-term ups and downs. Furthermore as the figures include the reinvestment of dividends, the compounding effect increases over longer time periods.
When it comes to investing, the earlier you start, the better. If you are 20 years old, start now. If you’re 50 years old, and you haven’t begun, there’s no better time than the present. You’ll never be younger than you are right now.