The Magic of Compounding
Dear Liberated Stock Trader this article will show you what you need to do to become a millionaire. Yes really. However it is not as simple as it may seem. The key things you will need are:
- Some starting Capital
This article will not guarantee you will become a Millionaire, however it will show you how compounding your earnings over time can get you there.
What is compounding?
Compounding means in simple terms if you have $10 and you earn 10% on it you will have $11. If you then compound this money with another 10%, you will actually have $12.10. You have earned an extra 10 cents, on the previously earned interest. Do this long enough and the compounding works to accelerate your earnings.
This means you need to continually earn a steady income and continue to reinvest.
So how will this make me a millionaire?
Let’s take some real examples.
Scenario 1: I have $2000 and I invest that at varying interest rates.
The table below shows what you will earn at the end of each year and how long it will take you to become a Millionaire.
Please note the following assumptions.
Interest Rates Scenario’s.
6.5% per Year – equivalent to the S&P-500 average annual return over the last 39 Years
12% per Year – a good target for a private investor, or a Mutual Fund
25% per Year – close to Warren Buffets average annual return
30% Per Year – better than Warren Buffets Annual Return.
These targets are chosen as they give you an understanding of how important making money consistently over the long term is, and if you can get to 25% per year return, how long will you need. This also is not a guarantee that the S&P-500 will continue to earn 6.5% per year on average for eternity.
So what are the key points in the Scenario 1?
- If you invest in an Index Tracker, or mutual fund that tracks the S&P-500, and you invest $2000, in 99 years you would be a millionaire. (providing the index returned on average 6.5%) However, who reading this really believes you will live another 99 Years.
- If you were a private investor earning 12% per year (beating the market) or have invested in a managed fund returning 12% per year consistently, you would be a millionaire in only 55 years. Still a long time to wait I think you will agree.
- If you are as good an investor as Warren Buffet the greatest investor of all time, you would be a Millionaire in 28 Years.
- If you could beat Buffet and earn 30% on your investments year on year for 24 years you would be a millionaire.
So how can we speed this up? I want to be a Millionaire as soon as possible!
Well we can do 2 things.
Earn more than 30% per year, every year. What beat Warren Buffet, Very difficult!
We can use compounding more efficiently. By this I mean, add regularly to your investment pot.
Scenario 2. I have starting capital of $2000 and every year I add $2400 (or 200$ per month).
Now see the difference in the table.
So what has changed?
- If you invested in an Index Tracker, or mutual fund that tracks the S&P-500, and you invested $2000, adding $2400 at the beginning of each new year in only 53 Years you would be a millionaire. (providing the index returned on average 6.5%) 46 years earlier
- If you were a private investor earning 12% per year (beating the market) or have invested in a managed fund returning 12% per year consistently whilst adding $2400 every year, you would be a millionaire in only 34 years. 21 years earlier
- If you are as good an investor as Warren Buffet the greatest investor of all time, whilst adding $2400 per year, you would be a Millionaire in 21 Years. 7 years earlier
- If you could beat Buffet and earn 30% on your investments year on year for 18 years whilst adding $2400 per year, you would be a Millionaire. 6 Years earlier
That is the Magic of Compounding!
It is very important the percentage return you make on your investments, every 1 percentage point really makes a difference over the years.
Vitally important is you continue to add to your investment with external cash injections, to get you to your goal quicker.
Whether you invest in a mutual fund or take your destiny into your own hands, the possibility of becoming a Millionaire is there. It is simply a question of time!
* this article does not include calculations for tax liabilities
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