I am guessing after that Title, I have your full and undivided attention!
How many times have you read or heard claims that appear too good to be true? Particularly with property spruikers…notwithstanding the current turmoil in the real estate market...those puppies just never learn...or people punting on ‘penny dreadful mining stocks’ hoping they will jump from $0.02 to $0.04. How about Bitcoin with the promise of instant riches, or attending some ‘free’ seminar with the hope of learning some secret that nobody else knows meanwhile the only people getting rich are the organisers who con you into buying their wealth creation club membership. What’s sadder is many people believe this stuff…hook, line and sinker!!
What is it about creating wealth, that people are prepared to undertake significant risk, sometimes risk all they have, with the hope of getting it all NOW?
The truth is, you CAN actually double your initial investment in just one year, but it is not the way you may be thinking. Whilst it is possible to get a 100% return in year one from an investment, it is really not that likely, and if that is your investment style and goal, then I wish you all the best of luck (you will need it!).
What this article is really about is two of the most beautiful words I have heard, at least when they are said one after the other, and that is ‘Compounding Returns’. STOP, don’t stop reading…you have probably said in your internal dialogue at this point “yeah yeah, I have heard this before. If I invest $100 today, get a 10% return and reinvest that return, then next year I will have $110 and if I get the 10% return, then in year two I actually receive $11 instead of $10 in return. Whoop-dee-doo, one extra buck”.
Can I implore you to not consider it in terms of ‘in year two…’, but instead to have a longer time-frame.
The true beauty of Compounding Returns really kicks in over say 15-20 years.
Let me show you by a little illustration.
Let us assume that you have $100,000 to invest. Let us also assume that the rate of return received is 10% year on year (see note 1).
After year one, you achieve a return of $10,000 (ie. $100k x 10%), and reinvest this with your initial $100k, repeating each year.
If you keep reinvesting your returns, your $100,000 will double in 7.27 years after the initial investment (ie. it will be worth $200k). Your money will triple in 11.53 years ($300k), and will quadruple in 14.55 years ($400k), from your initial investment date. Do you see the number of years decreasing between each additional $100k of growth?! It took 7.27 years to earn the first $100k, however this gap reduced to 3.02 years to grow the initial capital from $300k to $400k.
Back to the title of this article, and you may be saying, Glenn that is impressive, but it is still not doubling my $100k in one year. Hang in there my impetuous friend…if you invested $100,000 and achieved a rate of return of 10%, and reinvested all income, you will earn $100,000 (your initial investment) in ONE YEAR roughly between year 24 and 25. Ie. all you invested in the first year was $100,000, with no more of your own money at all. In 25 years, it will actually earn you $100,000 in one year, ie ‘Double Your Initial Investment in One Year’. Oh, by the way, at this time, the portfolio will be worth $1,100,000 (yep, over a million bucks)…and should at that point you choose to withdraw the return, but leave inflation in there, such as receive 7.5% in your hot little hands and reinvest 2.5%, then not only will this initial investment of $100k pay you $75k a year, but it will continue to pay this amount, year on year, adjusted for inflation, until Kingdom come.
Now try and tell me Compounding Returns are not two of the most beautiful words aside.
The morale of my story…don’t be rash and make dumb financial decisions chasing after quick riches. Wealth is made over a lifetime, and should you be diligent, disciplined and dedicated, you can assure you will have financial security into the future.
Now, it may be true that for many people, they will only have a couple of hundred grand to invest once they have well and truly paid off their mortgage. However, do not lose sight of your superannuation…after all, this will prove to be most people’s largest asset, far exceeding their home…so treat it carefully, and invest it wisely and well. Further, unlocking equity in your home can have a similar effect, but that is for another article.
As a Financial Planner, it would be an honour to provide advice to help you on your journey toward financial security. Interested? Then do not be a stranger, and make contact.
Adept Financial Planning….Start Planning, Start Dreaming.
Note 1 it will never be the same every year…it is just an average! You may also believe that an average of 10% is a little optimistic over the past few years. However, Australian Shares have averaged 9.1% per annum, and US Shares have averaged 10.6% per annum, from 1988-2018 (source: Vanguard 2018 Index Chart, https://www.vanguardinvestments.com.au/adviser/adv/v/indexchart2018.jsp), so whilst there is absolutely no guarantee that a 10% return can be achieved, it is not outside the realm of possibility. For sake of comparison, if an annual 8.5% return was achieved, it would be year 30-31 when your initial investment is doubled in one year. Past performance is not necessarily indicative of future performance potential.
The above illustration does not take into account taxation: neither capital gains, tax on dividends, or franking credits…but you get the idea now of how Compounding Interest can work.
This article is of a general nature, and should not be construed as personal financial advice (after all, I do not know anything about you!). Specific, personalised financial advice should be sought from a licenced financial planning professional, prior to undertaking any investment decisions.
About the Author
Glenn Baker is a Certified Financial Planner, and the Senior Financial Planner and Principal of Adept Financial Planning Pty Ltd, a Corporate Authorised Representative of Capstone Financial Planning Pty Ltd (as of 02/08/2019), AFSL 223135, ABN 24 093 733 969.