“It is not about timing the markets, but rather time IN the markets”
In my first post, I mentioned how time is one of the most important tools available to any investor. When you set a long-term investment goal you give yourself the ability to withstand any ups and downs that the market will throw at you. I can’t tell you what the price of the S&P 500 will be next year, though I can say with relative certainty that it will be worth more in 30 years than it is currently worth today.
To give you a demonstration on the power of compounding interest, let’s look at an example. If I invest $1,000 today in a financial instrument that returns, on average, 6% per year, what would that be worth in 30 years?
Based on my calculations, that would amount to $5,743.49. The concept of compounding interest is the idea that as your money grows over time, your investment gains earn a return as well, not just the original money you invested. Within this example, in the first year your $1,000 is invested you are able to earn $60, based on the assumed 6% return per year. In year two, do you think you earn the same $60? Your return for the second year is $63.60. The reason this is higher is that you are earning 6% on the $1,060 you now have, instead of the $1,000 originally invested. That is the magic of compounding.
Adjust this prior example slightly and assume that instead of only investing $1,000 in the first year, you continue to invest $1,000 each year. As you can imagine this will drastically improve your results. Enter these inputs into a simple compounding interest calculator online and you’ll soon realize the amount of wealth you’ll create is ~$89,000 after 30 years of investing $1,000 a year and earning an average return of 6%.
Now within that example we assume an average return of 6% over the entire 30 year time horizon. It is obvious that there will be years you far exceed that 6% average and there are years in which you will fall short of that. In my view, the key is to remain invested through the ups and downs, without letting emotions get the best of you. I’ve read several articles that show the implications of mistiming the market and it’s rather astounding. Missing out on a few keys days over the course of a year can greatly impact your annual return. The solution? Try to remain even-keeled and calm when making decisions regarding your investment portfolio.
So what does this all mean? In short, time is your friend when it comes to investing; a small investment today could really become quite meaningful later in life. In truth, you can do your future self quite the favor by taking your first step toward financial freedom. I will discuss ways to invest in future blog posts.