Starting Low is Better than Not Starting
Welcome back to our series of articles where we embark on a journey towards financial well-being. If you haven't had a chance to read the previous articles, you can find them all here, designed to be read in order and offering a 5 to 7-minute read per article. Together, they form a comprehensive guide that aims to empower you on your financial journey.
In our previous article, we delved into the mind of the legendary investment guru Warren Buffet, touching upon essential concepts such as patience, consistency, time, and compound returns. Building on those discussions, we are now ready to dive deeper into these concepts, armed with practical examples and real numbers. As we explore, we'll also begin to scratch the surface of tools that can help us put these ideas into action.
In this article, we will embark on a fascinating journey into the world of numbers and uncover the concept of Compound Return or Compound Interest. Fear not, as I will strive to make this topic easily digestible, without delving too deeply into complex mathematics. Together, we will explore the power of compound returns and their implications for our financial well-being.
Usually, most people think that investment in any shape or form should start with some big amounts. Of course, if you start with a lumpsum, it is a kind of advantage. However, what if I don’t have something to start with. All I have my salary. Here where comes the role of Compound Return, using incremental investing or saving. But before talking about the concept, let’s talk first about Investing Vs Saving.
Saving Vs Investing
Saving involves setting aside a portion of our income and storing it in a safe place, such as a savings account or a piggy bank. The primary purpose of saving is to accumulate funds for short-term goals, emergencies, or unforeseen expenses. It offers a sense of security and acts as a financial cushion during times of need.
While investing involves allocating funds with the intention of generating long-term financial growth or income. It entails purchasing assets such as stocks, bonds, real estate, or mutual funds, with the expectation of capital appreciation or regular returns.
To grow your money and hedge against inflation, it is important to begin by learning how to save. By starting with saving, you can determine how to allocate those savings to investments and construct a plan that balances between investment opportunities and maintaining cash reserves. Rather than investing all of your savings, it is crucial to consider the best approach for growing your money while also ensuring you have sufficient funds readily available. This involves developing a thoughtful plan that strikes the right balance between investing for growth and maintaining a cash cushion.
In our upcoming articles, we will explore more the best practices for achieving a harmonious balance between saving and investing. We will delve into strategies that can help you construct a well-rounded plan or portfolio tailored to your unique financial situation, taking into account factors such as your salary and the amount you can allocate towards building a strong financial foundation.
However, let's shift our focus back to investments and the concept of compound returns.
Imagine you're an engineer who has never invested before. In my experience, I've observed that most individuals tend to fall into one of two categories. Some choose not to invest at all, fearing the complexities and overwhelming nature of the process. Others take matters into their own hands, opening brokerage accounts and attempting to navigate the market themselves.
The latter ones usually follow the latest news, seek guidance from "experts," and delve into basic technical and fundamental analysis, all in pursuit of the elusive "holy grail" that promises astronomical returns, often aiming for 100% per year or maybe more. They trade with leverage sometimes, or most of the time to be accurate. Unfortunately, this often leads to struggle, resulting in losses or stagnation. In all cases, the most valuable asset they end up losing is TIME. They become anything but true investors in its genuine sense.
10% Return is Better Than 20%
Let's consider an example involving an individual who started early in their 20s with a simple yet renowned strategy known as the dollar-average strategy. This strategy entails investing a consistent amount each month in a stock market index like the S&P 500, irrespective of market conditions, whether they are on the rise or decline. In contrast, another individual focuses on seeking the most optimal strategy that promises superior returns. As a result, he started in his 40s.
Meet Sarah, who starts investing $500 per month at the age of 25 in S&P500, earning an average annual return of 10%, as per the last 30-year annual return history. On the other hand, we have Adam, who begins investing at 40 and achieves double the returns of Sarah, with an average annual return of 20%. Let's examine their investment outcomes at retirement age, which we'll set at 60.
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We can see from the illustrations above that despite Sarah's lower average return, her early start and the power of compounding over a more extended period enable her to achieve a significantly higher portfolio value at retirement compared to Adam, even with his higher returns but shorter investment horizon.
By illustrating these examples, it becomes evident that starting early with a modest return of 10% can outperform starting late with double the returns of 20%. This unconventional approach challenges the conventional belief that high returns alone guarantee financial success. It highlights the critical role of time in harnessing the power of compound returns.
This is not to say that you shouldn't strive to enhance your returns. It simply emphasizes that choosing to start as early as possible, even with average returns, is far better than delaying your starting point in search of better investments or returns.
You Are a Company
Consider treating yourself as a company. Companies have operational revenues (your regular income) and allocate a portion for research and development (learning to increase your income and the way you invest). They never halt operations and investments to seek better returns. They continue what they're good at while developing on the side. Some results become positive, while others turn out negative.
If you desire to develop a better investment strategy that may drive insanely good returns, that's perfectly fine. Keep enhancing your learning curve, but make sure it is part of a well-defined plan rather than a random approach. The key is to JUST START.
In our next article, we will delve deeper into the concept of Incremental Investing or Dollar-averaging Strategy. We'll explore the instruments to use, the tools available, and how to automate the process for hassle-free investing.
Sources:
Investment Calculator: https://www.nerdwallet.com/calculator/compound-interest-calculator
Disclaimer: The information provided in this article is for general informational purposes only and should not be considered as investment advice. I do not guarantee the accuracy, completeness, or usefulness of any information presented in this article. It is important to do your own research and consult with a professional financial advisor before making any investment decisions.
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