We had yet another good week in the market, with the S&P 500 returning over 2%, for a year-to-date return of over 7%. While we expect continued volatility due to trade negotiations and consumer sentiment, the market is back on a bull run.
The magic of investing, however, is not a 2% return one week or a 10% return in a year. The magic is when that return is compounded. To explain, I’m going to use some round numbers because that makes the math easy for me.
A common misconception I hear is that you need bigger amounts of money to get a good return. That’s really not true. If you have a 10% return, it doesn’t matter if you have $100 invested, or $1,000, or $1 million. It’s still 10%; the only difference is the actual dollars. The size of your investment may limit access to certain investments, and fees may be higher for smaller accounts. But your return is your return, regardless of the size of your investment.
But here’s the magic. Let’s say I invest $10,000 and receive a 5% return. Ignoring taxes, you would have $10,500. If the account continues to make 5%, the next year you don’t just make $500. You make the $500 on your original investment. But you also make $25 on the money you made the year before. So this year, you made $525.
That’s compound growth – when the money you’ve made makes money. If an investment paid simple interest, in ten years at 5% you would have made $5,000 – 5% times the $10,000 investment times 10 years. But with compounding, in ten years you would have made $6,288.95. By reinvesting the growth each year, you made an additional $1,283.
Albert Einstein is credited with discovering the Rule of 72. It’s not exact, but as a rough approximation it works well. The formula states that if you take any interest rate and divide it into 72, the answer is how long it takes your money to double. So if you owe money on a credit card at 24%, the principal would double in just three years. If your money is sitting in a savings account earning half a percent, it will double in 144 years. But if you invest and earn 8%, your money will double in nine years. The real fun is when your $100,000 account becomes $200,000, then $400,000. Which is also why starting to save at an early age has such a large impact on retirement success.
Your action item this week is to check the subscriptions on your phone, and cancel any that you aren’t using.
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CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.