The ups and downs on Wall Street are a blessing for those skilled enough to profit from them consistently; for the rest of us, trying to time the market has proven to be a tempting and costly endeavor that is more than likely to leave you with empty pockets.
At Dividend.com, it’s no secret that we’re proponents of employing a conservative investment approach over the long-haul. One of the most compelling reasons for having a “big picture” perspective and a long-term investment horizon is because there’s no more surefire to improve your portfolio’s returns than by harnessing the power of compounding returns all the while maintaining market exposure [see also Market Timing the Best and Worst S&P 500 Trading Days].
When it comes to long-term wealth accumulation, simple money management moves can be just as, if not more, effective than trying to follow complex, in-depth guides that aim to cover everything under the sun from retirement planning to portfolio re-balancing.
In an effort to simplify the otherwise intimidating process of mapping out your route to building wealth, below we offer three visual examples to illustrate the importance of having a disciplined investment approach over the long-haul.
The Only Chart You Need to Understand the Power of Compounding Returns
The concept of compounding returns is simple, yet incredibly powerful. If you start with $100,000 today and you make 1% after a year, you’re left with $101,000. You could take that $1,000 profit and put it to work elsewhere, leaving you with the original $100,000 investment. However, by re-investing that profit, you could make more money without lifting a finger; if your starting balance the following year is $101,000 instead of $100,000, you’re going to be left with $102,010 at the of that year. That’s a profit of $1,010 compared to your initial gain of $1,000.
In other words, you could be generating more and more profit each and every year as long as you re-invest your earnings. Now let’s consider the example below, which assumes various rates of return, compounded over the course of 30 years:
As expected, the higher the return you’re able to generate, the more your investment grows. Digging deeper, however, your rate of wealth accumulation is also largely dependent on whether or not you reinvest your profits, as well as the number of years you have to put compound interest to work for you. The lesson here is simple: reinvest your earnings so that you may harness the power of compounding returns over the long-haul [see also Free Lunch on Wall Street: 21 Ways Investors Can Make and Keep More Money].
The Importance of Annual Contributions
The next step towards visualizing your path to long-term wealth accumulation is recognizing the importance of making disciplined contributions to your portfolio. That is to say, while compounding returns are powerful on their own, when you add regular annual contributions to the mix, that’s when things get promising for your portfolio.
Consider the visual representation below of the following hypothetical example: let’s assume you start with $100,000, but you also add $10,000 to that nest egg at the beginning of every year.
What a difference an annual $10,000 contribution can make! If you let your $100,000 grow on its own, assuming 1% annual returns, as showcased in the first example, you’re left with $134,785 after 30 years. However, if you’re capable and disciplined enough to make a $10,000 contribution at the start of every year, the power of compounding returns becomes apparent as you’re left with $486,112 at the end of 30 years, assuming the same 1% annual rate of return [see also The Ten Commandments of Dividend Investing].
The lesson here is simple: if you can, try to make regular contributions to your portfolio because this adds up greatly when you factor in the power of compounding returns over the long-haul.
Start Saving ASAP, and More
Being able to consistently make an annual contribution to your nest egg is a vital step along the road to wealth accumulation. Even more important is recognizing the impact the size of your contribution can make over a long-term investment horizon. If you think that saving a little bit more today has only a minor impact on your portfolio’s worth over time, you’re dead wrong.
Consider the visual representation below of the following hypothetical example: let’s assume you start with $100,000 and your annual rate of return is 5% over the course of 30 years. The graph below showcases the different ending values of your investment assuming various contribution plans, ranging from zero additional dollars to putting away an extra $15,000 in your portfolio at the start of every year.
The results after 30 years speak for themselves; putting away more money today has a big impact on your investments’ worth over a long enough time horizon. If you make no contributions, you’re left with $432,194 after 30 years, but if you could put away even just $5,000 every year, that nest egg could be worth $780,998, or approximately 80% more [see also 14 Executives Getting Rich Off Dividends].
The lesson here is simple: if you can, try to save more today, because that way compound interest can work more to your advantage, which is further amplified when you give yourself more time to accumulate wealth.
The Bottom Line
The road to riches is arduous, but it doesn’t need to be complex or confusing. Start by outlining an investment strategy that focuses on fundamentally-sound dividend stocks; next, put your money to work as soon as possible so that compound interest can start working to your advantage. Lastly, do your best to make regular contributions to your portfolio, this way you can effectively amplify the powers of compounding returns.