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In the Seven Dollar Millionaire’s view, compounding is the most important, yet least understood subject in investing.
It’s least understood, because while some people may understand it, most people don’t. The people who do understand it invest. The ones who don’t, don’t. They think the stock market is like a casino when it’s really the opposite. And it’s the most important because it is the biggest potential wealth creator in the world.
Compounding means that the gains you make on your investment are now yours to make more gains on next year, and the year after, as long as you don’t take them out
Imagine you own a house which goes up in value by 10%, from $100,000 to $110,000. Next year, the gains you make start on $110,000, of course. If it is 10% again, the gain will be $11,000, to $121,000, as it is now 10% of $110,000. Your gains are making you money.
This really starts to show over the long term as your investments double. If you invest a thousand dollars in something that doubles every ten years, you won’t feel like it makes much progress to start with: it will only be worth an extra $1,000 ten years’ later. And then only in year 20 will it be worth a total of $4,000.
In the next 20 years, though, it will become worth an extra $12,000 and in just 10 years after that, it will become worth $16,000 more. Your $1,000 will have become $32,000 in fifty years.
What’s really sad is that because most people don’t know about this, or fully understand it, they don’t invest, and so compounding, through inflation, works against them. Rather than their money doubling, the value of the money they make through their hard work halves, and then halves again.
Doubling every 10 years doesn’t need very impressive investing skills either. The S&P 500 has returned almost 10% for the last 50 years, and for every 50-year period since 1927, it has returned more than 9%. That means it would double every 8 years, not 10. That would mean that saving $7 a day would make you a millionaire 10 years early, in 40 years not 50.
If you carried on investing at the same rate for the next 8 years, your $1 million becomes $2 million. You would be a Seven Dollar Double Millionaire! The longer you compound the returns on your investments, the more impressive results become – but to do that you have to start early.
Featured in the FINANCIAL TIMES, and the DAILY TELEGRAPH, our MISSION is to help create millions of millionaires. We want people all over the world to use our simple tools to save emergency funds, turn those into investment plans and create the habit that will help enrich their lives.
If you’re interested in financial literacy, please also look at our new project www.maiawards.org