- Long term investing is one of the most powerful ways to grow your money, and understanding the simple reasons why can help you make powerful decisions for your money
- There are three ways you can harness the power of the long-term for your portfolio: invest early, reinvest your earnings, and stay diversified
It’s easy to make jokes about how nothing you learned in high school math is useful in your adult life, but there is one math concept—that isn’t given quite the pomp and circumstance it deserves—that can have a hugely positive impact on your financial life:
Don’t worry, this isn’t going to devolve into a technical math lesson. Looking at investment returns over time is pretty basic math, but it’s basic math that can help you grow your portfolio over the long term.
It’s also the best reason to start investing as early as you can, even with amounts that seem like no big deal.
Why invest for the long term?
When you’re investing, you’re expecting a return on your investment. The best way to get that return is to give your investments time in the market, which is when you’re more likely to see your money grow over time along with the market.
Consider this example: If you had invested $10,000 in the S&P 500 index on January 1st, 1990, your money would have grown to over $130,000 by the end of 2017, just by leaving it alone to grow alongside the market.
While you can’t go back to 1990 to start investing then, you can do the next best thing. Start investing today, and you’ll be exposed to market growth in the future—although when you do start, make sure your investments are diversified.
However, you’ll also be exposed to potential losses, which can be scary when you’re just starting out. Luckily, over the long-term, growth trends tend to work in your favor.
While past performance is no guarantee of future results, you’re more likely to see growth the longer you’re in the market—even if your first few years aren’t the strongest performers.
This example illustrates the different performance over time from the highest-performing and lowest-performing time periods investors could have experienced with the S&P 500.
Over a year, you can see pretty large differences in returns, but over the long-term, your returns tend to become more stable, with even the lowest-performing time period delivers a strong return at 9.03%.
How to Start Investing for the Long Term
When you’re starting to invest, it’s easy to think that the amount you have available isn’t enough to make a difference, especially when you’re staring down a lofty goal like a house down payment, a wedding, or retirement.
But even small amounts can make a big difference when invested regularly over time.
There are a few ways you can make sure that this works in your favor when it comes to your investments.
You’ll really start to see growth when you’re investing for the long term*.
One way to estimate the impact of investing over time is called the Rule of 72.
If you assume an annual rate of return, you can use it to estimate how long it will take for your initial investment to double.
Divide 72 by your expected return as a number. Let’s say you expect to earn 5% per year, so you divide 72 by 5—your investment would double in about 14.4 years.
If you’re earning 2% in a savings account, it would take you about 36 years for your returns to double your original investment.
Reinvest your earnings
If you withdraw the money you earn from your investments every year, your balance will grow more slowly, which is why it’s important to keep your returns invested to see the best results.
Here’s an example:
Let’s say you’ve managed to save up $10,000 (high five!) and you invest it in the market. You earn 8% in one year, which means you’ve got an extra $800 in the account.
If you leave the $800 invested, any additional return will be earned on the full $10,800 next year.
So if your investments go up 10% in the following year, you’d earn that 10% on your full $10,800. However, if you take out your earnings, you’ll only be earning returns on your original $10,000.
Over time, that will make a big difference in your results.
Everyone’s heard a horror story of a single stock crashing, and losing almost all of its value, whether it’s Enron or an e-commerce company that went bust in the early 2000s.
Those stocks saw big growth for many years, but one bad year wiped out all of their gains.
If those stocks were just a small part of a diversified portfolio, however, investors might have been able to rely on other investments to perform well, and kept their overall portfolio from going into the red. That’s what makes diversification such a key part of achieving long term growth.
That’s what makes diversification such a key part of achieving long term growth.
Investing 101: Let’s do this
Investing doesn’t have to be something scary and intimidating, and it’s one of the most powerful ways you can hit your goals and build wealth over the long term.
Make a Plan:
- Should I Save or Invest?
- Understanding the Stock Market
- Long-Term Investing
- The Relationship Between Risk and Return
- Investing for Beginners
- The Benefits of Diversifying Your Investments
- Types of Asset Classes
- 5 Common Investing Mistakes
*Investments are not FDIC insured – No Bank Guarantee – May Lose Value.
Investing involves risk, including loss of principal, and past performance does not guarantee future results. Diversified portfolios and asset allocation do not guarantee profit or protect against loss. Nothing on this site should be construed to be an offer, solicitation of an offer, or recommendation to buy or sell any security.