We strongly support “all women in investing! But why should you actually start investing? You can leave that savings pot for your old age in the bank, right? That is indeed a choice you can make, but there are several advantages to investing. One of the biggest advantages is the so-called compound return, also known as “compound interest. Compound interest was called the 8th wonder of the world by Albert Einstein and is also the secret behind “money becomes more money. But compound returns, what exactly is that? Read, learn and invest!
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Compound returns: the eighth wonder of the world
Compound interest: Albert Einstein called compound interest one of the greatest forces in the universe. “Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” It is the principle where your money makes a return and that return in turn earns a return for you.
It is an effect that is getting more and more powerful, because it is like a snowball effect. The two variables that determine the degree of the effect are efficiency and time. The higher the return and the longer the time the investment can do its work, the greater the compound effect. This means that investing is a business for patient people. It is sometimes said that the best investors, are dead investors.
Example of compound return
An example to explain the effect of compound returns is nice. In this calculation example, we assume an 8% return on your invested money. This is a historical average return over the years on stocks and ETFs. So some years the value of securities in the stock markets increases tremendously, and some years they decrease, on average the return is around 8%. If you invest €1,000 now, and this amount has increased in value by 8%, you can withdraw €1,080 after year 1. So your deposited pot of money becomes more valuable.
Then the return of year 2 is calculated on that 1,080.00 euros. So in year 3 you have €1,080 + €86.40 = €1,166.40.
Give this 10 years, and your deposited €1,000.00 will be worth €2,159.00! Didn’t have to do anything for it. In 10 years, your money doubled.
But suppose you have 20 years, then suddenly your deposited €1,000 euros is worth €4,661 euros.
How to take advantage of compound returns?
But how do you take advantage of this? Ultimately, your gain or loss is not real until you cash out. So when you withdraw your money, you experience what your return has been all these years. But recording that, you don’t want to do that too soon. At least, not on your long-term investments. Why not? Because these assets make returns every year (or sometimes one year not). So after 1 year, the compound interest effect has not brought about that much, but after 5 or 10 years it has brought about considerably more.
In addition, the stock market is volatile, that is, movable. Sometimes rates rise and sometimes they fall. This is historically normal, and a stock market dip has always recovered. So if you invest for a long period of time, you don’t have to fear the price fluctuations so much.
Suppose at some point you have a ton of assets, and you make a nice return one particular year. Then you can withdraw the profit amount, and use it to live on. You can leave the rest of your already accumulated wealth to “do its job.
Dividend shares
If you invest in dividend stocks, the compound interest effect can do its work even harder! Because dividend stocks pay dividends, you make money on your investments. You can either pay yourself this dividend, or reinvest it. If you reinvest your dividend, then you buy more shares with your earnings from dividends, which make you more money, from which you buy more shares, and so on. This is how your money becomes a true money machine.
Want to read more about the basics of investing? You can do that here!
