Compound Growth: Investing’s Holy Grail
Each person has their own unique financial goals. These goals have various time constraints and final amounts. Are you intending to build overall wealth? Do you want to save for your child’s education? Do you want to ensure you have a nice nest-egg for your retirement? All of the goals are united by one unique factor – time.
What can be hard to calculate, or visualize, is how you can get from point A to point B. It’s a marathon— not a sprint— for many and compounding growth can be the most powerful tool for people to accomplish their goals.
Compound growth is like a snowball rolling down a mountain that keeps getting bigger and bigger. With time it picks up speed and quickly doubles, triples, and becomes a force of nature. After a few good years of returns and allowing the investment to keep growing, you will be surprised to see your small investment become much larger down the road.
For those of you are more mathematically minded, here are some numbers behind the theory of compounding growth. A simple way to explain compounding growth is the rule of 72. The expected rate of return: let’s say for this example 8%, is what you expect on average to obtain. According to LPL Financial, from 1928 to 2016 the average return for the S&P 500 was 9.8%. Take 72 and divide the rate of return and this will determine how many years you will need to double your investment (i.e. 72 ÷ 8 = 9). Thus, you can double your investment return every 9 years you will double your savings with an 8% expected return.
If you can do this in a tax-deferred account, such as 401k, IRA’s, and/or a 403b, it is icing on the cake as you aren’t taxed while growing your net worth. In a taxable account, there are certainly some long-term strategies you can use, like index funds and annuities, that will allow you still to take advantage of compound growth and tax-efficiency.
To illustrate my point, here is a hypothetical example. Sally, a young professional, is able to save for retirement starting at age 25. She puts away $25,000 in an aggressive investment and expects to earn 10% annually on average. If she uses compounding growth, and stops contributions her $25,000 investment will be worth $1,131,481 when she is 65. There will certainly be some ups and downs on the roller coaster ride with the stock market, but her outcome will be much better than a bank account and avoiding get-quick-rich schemes and sticks to her plan to utilize compound growth.