Some of us may have heard about the power of compound investing. For everyone's benefit, I shall illustrate this in this blog post, as I feel it is a vital aspect of learning how to invest.
To go about compounding your investments, we need to see investments as income producing assets, generating cash flows for us through distributions via dividends. In order to allow for compounding to work, we need to put this money from dividends to work. By re-investing our dividends into the same or other income generating assets, we have increased our income as a result of the larger investments made.
Let us have an example to illustrate its true power. In both scenarios, we see how long it takes to achieve a million dollars starting from a $10,000 investment.
Investment + Dividend Re-Investment
At Year 0, we decide to invest $10,000 into an asset yielding 8%, re-investing its dividends at the end of the year.
So we note that we need a minimum of 60 years for a million dollars to be generated, both in terms of total interest earned and the total net worth of the capital invested. The passive income generation would be a cool $6,750 per month.
But this takes 60 years, a way too long an investment horizon for many. Perhaps we could speed things up by injecting more funds annually.
Investment + Dividend Re-Investment + Injection of funds
At Year 0, we decide to invest $10,000 into an asset yielding 8%, re-investing all dividends and injecting a fixed $7,800 ($650 monthly) at the end of the year.
So we see the marked difference, just by setting aside an extra $650 from our salary per month, we can reach a full million worth in capital invested in just 30 years, half the time if we did not contribute at all!
Now we see the true power of compound investing and the rewards of being disciplined in saving and investing consistently through the years. Every single year and every contribution counts, so starting early gives us the critical advantage. Remember, with every delayed gratification, comes an even greater reward in the future. Good Luck!