The Biggest Secret to Investing, Compounding Returns
By Floyd Saunders, Founder at Really Simple Investing
There is a secret to getting rich. Your banker will not tell you about it, Perhaps not even your financial advisor. But you need to understand how compound interest works. Once you do and start to apply to your savings and investing approach, you will be on the path toward financial freedom.
The Most Powerful Force on Earth is Compounding Returns
The secret to this approach is in the compounding effect that Albert Einstein once called "the most powerful force on earth."
This investment strategy over time is the one approach that can make anyone a millionaire if they are smart enough to stick with it. You see compound interest doesn’t care if your are smart, or pretty, have a lot of money to start with or just a little bit. This is one rule that can work for anyone who will stick to the strategy of compounding your returns by reinvesting for 10, 20, 30 and especially 40 years.
What is this? you ask.
Compounding Your Investment Returns
That's where the Rule of 72 comes in. The Rule of 72 says that in order to find the number of years it takes for you to double your investment at a given rate just divide the yield into 72.
For example: If you are earning a 9% dividend on your investment, it only takes eight years to double your money, and roughly 13 years to triple it.
This compounding effect arises when your dividend yield is added to the principal, so that from that moment on, the interest begins to earn interest on itself.
Over time, that process can add up to a small fortune even with a very modest start. Using this simple but effective strategy, you can build a reliable nest egg in just 40 years.
Let's say you took that $10, 000 you have in the bank earning nothing and invested it in shares of Duke Energy Corp (NYSE: DUK).
Doing so, you would be buying about 475 shares of a solid company that also happens to pay a 4.7% dividend yield.
Now that may not seem like much- but one day it may just be the best investment you will ever make.
That's because at the ripe old age of 25 you make the smartest call of your life. You decide not only to reinvest those dividends but also to contribute another $50 a week to your cause. When you wake up 40 years later you will have accumulated a $1,029,743.08 nest egg assuming the underlying share price grows a modest 4% a year.
But that's not all. You would also have an investment that now throws off a $44,420.54 yearly income stream if you need it.
Better yet, if you let this investment ride just another five years and decide to retire at age 70, your pile of cash would grow to $1,576,981.27 with an income stream of $68,082.17 a year. And all you have to do is stick to the plan. And of course, make sure your investment in Duke Energy lasts.
The good news is there are lots of companies that have been around for 40 years or more and have paid out increasing dividends every year. That’s what it means to be an income investor who understands time.
By comparison, starting at age 25 and contributing the current maximum of $551/month your estimated Social Security check would be just $51,000 a year at retirement. That's it - no cash cushion, no nest egg, and nothing to leave to your children.
You need to understand how interest works, because your banker does. Just use this simply compound interest calculator. Interest can either be financially beneficial or detrimental, depending upon whether you are the borrower or the investor.
When you’re the investor, take advantage of compounding interest, and be certain to start saving early. When you’re the borrower, always utilize self-control with your finances.
As you increase your financial knowledge, and hopefully increase your financial wealth, give careful consideration to interest and how it affects your finances. Seek out loans and credit cards with lower interest rates, while also growing and contributing to your investments to the point that their interest compounds. If lenders can benefit from high interest, you certainly can too.
You can learn more in the book, Five Paths to Wealth by Floyd Saunders