Compound Investment Returns – A path to achieving your investment goals
The topic of compound interest is a powerful investment concept that is essential for any personal investment strategy. Compounding can help you to slowly and steadily achieve your investment and retirement goals. Compound interest, or more commonly called “compounding” is defined by Wikipedia:
In a simple example, compound interest, or compounding your investments can be accomplished by seeding an investment account and allowing that investment account to grow over an extended period of time without withdrawing any funds. Over time, your investment will most likely generate capital gains, interest or dividend payments from your initial investment of capital. Here’s the essential part of compounding your investments: You must reinvest those new returns back into your investment strategy and allow that new cash work for you. When you do this, you will see your total invested capital grow slightly, and now your investment base is slightly larger than it was before. The reinvestment of returns over time can help your investment account to grow at an incremental rate.
To enhance the compounding of your investments, you should consider setting up a recurring investment each month into your investment accounts. The key to compounding is to allow any and all money to remain within the investment account and to reinvest any cash received back into your investment strategy.
To further this example, if you set up an investment account with $100,000 and it grows annually at 5% over 25 years, the total will grow to $339,000. In addition, if you also contribute $200 per month using the same example, your investment will grow to $453,000.
If you increase your expected return on your investments from 5% to 8%, you can start to see substantial growth in your returns over the same 25 year period. By slightly changing the assumption of growth rate from 5% to 8% and keeping the $200 per month contribution and an initial investment of $100,000 you will see your investments grow to approximately $860,000.
So what are the key tenets of compounding your investments:
- Invest consistently - Develop an investment plan that you can adhere to over the investment horizon.
- Reinvest - As most investment accounts generate cash over time, it is essential to allow your money to remain invested and allow your earnings to reinvest back into the investment strategy.
- Tithe to yourself - Set aside as much as you comfortably can each month to bolster your investment and savings accounts.
- Limit Withdrawals - Your investment account has the best chance of performing well if you avoid taking funds out of it. Allow your money to grow and also allow any interest or dividends to remain invested inside of your investment account.
- What if you fall off the horse? - Like all things in life, it’s hard to remain consistent for multiple decades. For example, over a 25 year period real people may find challenges in contributing a consistent amount, and it’s hard to commit to never withdrawing funds from your investment accounts. What’s important here is the concept, and staying dedicated to the concept of investing for the long term, staying consistent and committed to your investments.
Individual investors should be aware of compounding as a key concept to implement and consider during the planning phase of an investment strategy. You can visit Investor.gov to use their compounding calculator.
Interest rates are going to change...or are they?
The topic on all investors minds is when are interest rates going to change and by how much? In a world of globalization, Brexit, Chinese currency valuation concerns, trade wars, and Trump uncertainty, we investors are trying to gauge just how quickly rates will continue to tick upward.
It is interesting to see the FED vacillate between uncertainty over the economy, and Trump's rhetoric about obtaining 3% GDP growth over the short term.
With Trump and his agenda only as reliable as his Twitter app, who knows what the future holds for the Trump White House. Janet Yellen seems to be hanging on the words of Trump and not the action of Trump. We've heard a lot from Trump about a Wall, higher growth rates in the future, immigration, repealing Obamacare(also known as the Affordable Care Act), and more.
But where do the economic tires meet the road... Let's not forget that when Obama took office there were about 80 million people of working age who were not participating in the labor force, this number now stands at about 95 million workers not participating in the Labor Force. This is the highest number of Americans not participating in the labor force in the last 35 years and it's a record. Rate hikes are often conducted to slow an overheating economy, to pull money out of the economy and to slow growth and inflation expectations.
But if the economy was truly overheating with rising wages and with a low unemployment rate, wouldn't the labor force participation rate be improving and not deteriorating? Wouldn't higher wages draw idle workers back into the workforce? Since Obama became President, the Labor Force participation rate has been deteriorating and not improving.
Yet another sign of economic fragility comes from the SNAP program, otherwise known as "food stamps". When Obama took office in 2009 there were 32 million benefiting from SNAP, by 2016 that number had grown to 43 million receiving benefits.
Rates are expected to change in March 2017, but due to our tenuous economic footing I don't expect the FED funds rate to become as parabolic as some fear. So despite the prevailing uncertainties, the progression of rates will likely follow a muted rise as both Yellen and Trump look to prevent an economic relapse.
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