Albert Einstein called compounding returns the 8th wonder of the world. It’s no joke. Money invested properly can grow to immense value over the long-run. The key phrase there is ‘long-run’. Investment compounding is a process that happens over time, not overnight. We at TFC believe that the sooner you get invested, the better your chance at long-term financial success.
The Rule of 72 is a rather simple formula that determines how quickly it takes for money to double. I.e. if the historical market return near 8% is what we expect going forward, it will take 9 years for that money to double in value. Here’s the math – divide 72 by that 8% return which will produce 9 years. But here’s the catch – the market and investment returns do not produce straight-line returns.
It takes patience and a steadfast long-term plan to achieve ‘average returns’. There have been decades during which the market has produced outstanding returns and decades when an investor has earned near 0%. The key is to remain committed to our strategy, rebalance your portfolio, and utilize a low-cost & diversified portfolio. This is what we do at TFC. We are here to help make that plan happen for you.
Compounding happens quicker in tax-advantaged accounts. After all, you have to pay the tax-man hefty amounts if you are not careful. At TFC, we believe in using accounts such as Roth IRAs, Traditional IRAs, 401(k)s, Health Savings Accounts, and other vehicles designed for investing for the long haul.
It can be hard to stick with the plan at certain times, however. Market volatility, social media & 24/7 news, your colleagues at the office constantly talking about the latest hot stock – all of these are distractions from smart long-term investing. We don’t try to double your money from day to day, week to week, or even year to year. True compounding is like a roll of toilet paper (bear with me on this analogy!) – the closer you get to the end, the faster it seems to go. Meaning it is not until you have been invested for decades do you see how big compounding can get.
Another benefit to keeping the right perspective on the Rule of 72 and compound returns – today’s volatility is hardly noticeable in the long-run if you keep contributing. Take a look at the long-term chart of the U.S. stock market pictured below. Remember 1987? I’m sure you do if you invested through it, but you can hardly see it on the chart! So, while a bear market can be scary, it should be seen as an opportunity to buy when stocks are on sale.
S&P 500 Index since 1950 (via MacroTrends.com)
Here’s the point:
- The Rule of 72 is a back-of-the-envelope calculation to determine how quickly it takes for your money to double in value.
- At an 8% rate of return, an investment would hypothetically double every 9 years.
- Creating and sticking with a long-term investment plan is the key.
- Volatility today often means an opportunity for later investment returns.
Action Items:
- Let’s sit down and determine your personal risk & return objectives to get you on a path to financial success; let compounding work for you starting this year.
- Take time to assess if you can afford to put more toward your retirement savings accounts like an IRA, 401(k), and HSA.
Photo by Mathieu Stern on Unsplash