Compound Your Way to Financial Success
Albert Einstein referred to compounding as the eighth wonder of the world
Investing early harnesses the power of compounding and is one of the most potent strategies for wealth creation.
Compounding refers to earning returns on both the initial investment and on returns from prior periods. Here's how it works:
Year 1: You invest $1,000 and generate an 8% return for a gain of $80
Year 2: You now have $1,080, which at 8% would result in a gain of $86
The longer this process goes on, the more dramatic the snowball effect of earning "interest on interest" would be.
There are two components to fully benefiting from compounding:
Save Diligently
Regularly spend less than your monthly income, leaving you with a surplus which can be added to your investment portfolio.
Use a budget to track income and expenses - separating expenses into needs and wants.
Identify and cut unnecessary expenses and look for value over luxury.
Controlling expenses will also help avoid high-interest debt like credit card balances.
Invest Early
Focusing on savings will help you begin investing early in your career, allowing you to fully benefit from the power of compounding.
The following example demonstrates this.
Jen starts saving and investing early. She invests $1,500 each year for the first 15 years of her career (total investment: $22,500).
Meanwhile, Maggie starts investing 10 years later. She also invests $1,500 and does so for twice the number of years (total investment of $45,000).
Despite investing half as much as Maggie, Jen ends up with a significantly larger portfolio. This is because Jen started investing early, and there was more time for her investments to compound.
The next step to get started would be deciding on the appropriate asset allocation. Devise an asset allocation that aligns with your financial goals and tolerance for risk. For more on this, refer to the following post: Your Financial Future Depends on the Right Asset Allocation
Disclaimer:
All content, information and opinions provided on Fincoaster are for informational and educational purposes only. Nothing contained herein is investment advice or recommendations. No guarantee is provided about the accuracy or completeness of the information provided. Readers should consult their financial advisers to ascertain the suitability of any investment.
Contributors to Fincoaster may, from time to time, have positions in any investments discussed.
Fincoaster is operated and managed by Envision Ventures Limited.