How Wealthy Can You Become With a 10% Annual Increase?

A simple 10% annual increase from an asset within your portfolio can be a solid start to a stable path of wealth if a good investment strategy is implemented. The sooner you start looking at methods to multiple your initial investment returns, the more likely you are to set yourself up for greater upside in the future, but you must start now.

One strategy that can be highly effective is compounding. It is the ability of an asset generating earnings that will then be reinvested to generate their own earnings. Primarily, it refers to creating earnings from previous earnings. The main benefit of reinvesting earnings income from your investments is that it can be used to buy more shares which will potentially grow in value and boost your overall returns.

Compounding Your Investment Returns: An  Example

Let’s say you make an investment of $5,000 into Facebook (FB). The first year, the shares rise 20%. Your investment is now worth $6,000. Given the solid performance, you decide to hold the stock. In the second year, the shares appreciate further, another 20%. Therefore, your $6,000 grows to $7,200. Rather than your shares appreciating an additional $1,000 (20%) as seen in the first year, they appreciate an additional $1,200, because the $1,000 you gained in the first year grew by 20% too.

Extrapolating the process out, these numbers can start to grow substantially. Putting the compounding effect into monetary context, the $5,000 invested at 20% annually for 25 years could see growth close to $500,000. This would be the growth without having to add any additional funds to the investment.

The Eighth Wonder of the World

The beauty of compounding returns has been referred to as the eighth wonder of the world. Compounding is also an investor’s best friend. It gives you the ability to see a transformation in your working money to become a highly powerful income-generating tool. To work, it requires two key things: the reinvestment of earnings and time. If you are giving more time to your investments, then the more you will be able to see an acceleration of the income potential for your original investment.

Albert Einstein states “Compound interest is the greatest wonder in the world. He who understands it earns it, he who doesn’t pays it.”

Patience is, however, the essence; seeing the full benefit of compounding your returns is all very much about time and patience. You don’t have to stash half your capital available away immediately. If you can consistently and gradually commit to putting aside as much as you can every month and making regular contributions, small amounts can soon add up.

Investment for Leveraging Compound Returns

Aside from stock dividend payments as in the example earlier, a classic case for compounding the returns is also applicable with simple deposits into the bank such as savings accounts, fixed-term deposits and certificates of deposits.

In terms of fixed income, i.e. bonds, the annual or bi-annual interest payments received can be reinvested to purchase other bonds or securities. There are some specific bonds, for example, the zero-coupon bonds, which automatically include compounded returns.

Initial Required Capital

Initial capital is solely down to each individual’s financial conditions, i.e., whatever you can afford to put up front. I believe a range of $5,000-10,000 is a good amount that can be life-changing down the line. However, again this comes down to you; it could be a more significant amount of capital or as low as $500.

Start Saving Now

Look at creating a plan or a goal of how much initial capital you want to start with. Let’s say it is $5,000 and you want to have that within the next three years. Breaking it down, this would require you to put away around $138 per month. You can see when this is stretched out over the period, the number isn’t so intimidating and is very much manageable.

On a similar scale, looking at the case of your goal being $500 over that same 3-year period, the monthly put-away would be as nominal as $14 per month.

Start saving now (as much as you can), and ensure you invest it well. This means lots of research and due diligence. The sooner you get the wonder of compounding working for you, the sooner you’ll reach your financial dreams and goals.

Risk Warning

As the case with all investing, your capital is at risk. The value of your portfolio, whatever you may be invested in, can go down as well as up and you may end up getting back less than you initially invested.

Summary

As broken down within this article, compound returns are something that investors should thoroughly understand, given its robust capabilities. You should always keep in mind the critical aspect of successful compounding investing is time – maintain that patience and you will be paid handsomely.

Featured image courtesy of Shutterstock.

Author:
Ken has over 8 years exposure to the financial markets. During a large part of his career, he worked as an analyst, covering a variety of asset classes; forex, fixed income, commodities, equities and cryptocurrencies. Ken has gone on to become a regular contributor across several large news and analysis outlets.