Wise Investors Let Investments Snowball over a Long Time
By Saghir Aslam
Irvine , CA
(The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
The most powerful investment tool available to investors is not the hot stock tip or the perfect timing method. It is the awesome power of compounding.
Over the long haul, you can make huge amounts of money if you invest regularly and allow the earnings acquired on this money to accumulate. This type of compounding, rather than flashy option strategies, short selling or Internet stocks, is the only way to make sure you have money for the future.
How does compounding work? An extreme example is as follows: Let’s say you invest $1 at 100% earnings per day. At 100% earnings, you will double your money each day. You will have $2 the second day, $4 the third day, and so on. On a $1 investment, you will earn more than $1,000 in 11 days.
Each day, you are acquiring earnings on the previous amount. This is compounding at work, a process that allows you to earn money on the original investment and those that follow. Considered this over a number of years, the true picture of compounded earnings will be painted.
Of course, you will never earn 100% earnings per day. Let’s consider the power of compounding as it applies to more realistic investments.
Compounding is a powerful tool, even if you have just modest amounts of money to invest. For example, if you invest just $100 a month, you will have put in $6,000 after five years. And if your return was a meager 5% on that amount, you will have earned an additional $800.61, before taxes, on top of the $6,000.
This might not sound like a lot of money, but hang on. Remember, compounding means that you are acquiring earnings on the amount you have already gained. The longer you let compounding work , the more powerful it becomes.
After 10 years your $100-a-month investment will be worth $15,526.23. This amount will swell to $26,726.89 after 15 years, $41,103.37 after 20 years, $59,550.97 after 25 years, $83,225.86 after 30 years, and $113,609.24 after 35 years.
After 35 years, you will have made 420 monthly contributions of $100, for a total of $42,000. But you will have earned nearly twice this amount, or $71,609.24, in earnings.
Now consider how much you would have earned if your contributions were more than $100 a month, and if you put your money into a diversified growth fund, which would likely generate a higher return over the long haul.
Since 1926, large-cap stocks have returned an average of 11.2% a year to investors.
If you put $1,000 a month into a taxable mutual fund that grows an average of 11% per year, before taxes you will have $216,998 after 10 years, $454,689.57 after 15 years, $1,576,133.30 after 25 years, and $4,928,296 after 35 years. (See the Long View above.)
Investments of $1,000 a month for 35 years, compounding at a yearly rate of 11.2% would grow to $5,195,617, an extra $267,321.
In any case, this means that if you can afford to invest $1,000 per month, you will be a millionaire in 25 years.
Inflation and taxes, of course, will lower these returns, but there is still no safer way to accumulate money than long-term investments that are allowed to accumulate. For example, a mutual fund investment that earns 11.2% a year will double in value about every 6 ½ years.
While the power of compounding is awesome, many people are too impatient to use it.
We live in a society that favors immediate gratification of needs. People want the money now. They are afraid that they will be dead before they can use the money earned by compounding, so they look for a hot stock tip, or they play the Internet stocks rather than stick to a long-term investment program. These people often lose in the long run.
They lose because they invest in risky stocks, only to break even or lose money. They waste the years that they could have been earning money.
Today people are living much longer, and the later years are when you really need the benefits of compounding. You should start a compounding program early, stick with it, and do not deviate.
Charles Carlson, co-portfolio manager of Strong Dow 30 Value Fund, believes that people should be taught about the power of compounding when they are young, before they are tempted to invest by seeking the big, immediate score.
I never cease to be amazed by the power of compounding. Earlier this year, while discussing among my friends I gave them a demonstration of the power of compounding and they were impressed. I told them not to look for the hot stock tip, but to stick to a program and start early. Hopefully, more people are getting the message.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr. Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, or does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr. Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr. Aslam does not have anything for sale.)