The Power of Compounding: Stay Invested for Long-Term Financial Growth

When planning for your long-term financial goals such as retirement, don’t let short-term market volatility distract you from the benefits of long-term investing.

The Power of Compounding

Being in the market, while assuming risk, means that your investment benefits from compounding growth when your investment’s earnings are reinvested, to earn even more. The longer your money remains invested, the greater the potential for compounding and growth. While compounding generally has a substantial long-term impact, keep in mind that there may be periods when your money does not grow. While it isn’t guaranteed, the compounded earnings over several years may significantly outweigh your initial payments. By utilizing this potent energy and investing wisely, you can increase your retirement savings more quickly than by simply putting money away.

Interest earning interest

How does compounding work to an investor’s advantage? In this case, if your investment of $10,000 earns 10% per year, the $1,000 you would make brings your balance to $11,000. The next year, if you earn 10% on that amount, you would earn $1,100. The longer you’re invested, the longer you have to accrue interest.

Of course, if you are investing in stocks, that rate of return is not guaranteed. Your returns may be lower, or even negative, in some years. In other years, you may see even greater gains.

The earnings can grow even more quickly if your investment is held in a tax-favored retirement account (one that isn’t taxed until you withdraw the money in retirement). Add in regular contributions and it’s easy to see why accounts like 401(k)s and individual retirement accounts can be powerful tools for saving.

History shows that the longer you stay invested, the more time your potential earnings get to compound and the greater your potential growth. That’s why financial professionals often recommend that the best time to start investing is as soon as you can. It’s also a great strategy to stay invested for the long term.

Why It’s Important to Start Early

Starting your investment journey early allows you to harness the power of compounding, where your account’s earnings generate additional earnings. Over decades, compounding can make a significant difference in your portfolio’s value.

Example:

If you are still skeptical of the significance of contributing to your retirement early on, consider these scenarios. If you start contributing $100/month at age 35 and earn an average annual return of 8%, your balance after 20 years would be $130,519. If you start at age 45, your balance would only be $58,902. Even small early contributions can significantly benefit from compounding growth.

Why Timing the Market is a Bad Idea

Attempting to time the market is generally a poor strategy. Many investors react to downturns by exiting the market, which can lock in losses and prevent them from benefiting when the market rebounds.

Example:

Consider a hypothetical $10,000 investment in the S&P 500 Index made on July 1, 2013, and held for 10 years. Despite enduring two bear markets, this patient investor would see their portfolio nearly triple. Conversely, attempting to time the market and missing some of the best days would significantly harm long-term results. Successful investing relies more on time in the market rather than timing the market.

Tips for Staying Invested Long-Term

Set a Goal

Define your investment goals to manage expectations and reduce emotional decision-making. Reacting emotionally to market events is normal, but impulsive actions can jeopardize your investment success. Focus on long-term strategies and maintain control over your reactions to achieve better outcomes.

Often, market downturns causing declines in stock prices trigger fear in investors, causing them to sell to avoid further losses. This is due to loss aversion, the human tendency to avoid losses over acquiring gains. This cognitive bias is what causes investors to lock in losses of a downturn and miss the gains of a market upswing. When planning for long-term goals such as retirement, remember that staying invested will deliver returns much more than timing the market ever will.

Investing $1,000 in the S&P 500 from 1994 to 2023 would have seen calendar-year returns fluctuating from -37% to +38%, which could be very discouraging to an investor during negative years. However, over 30 years, the initial $1,000 investment would have grown to $18,176.

Make Recurring Contributions

Commit to investing a fixed amount regularly, regardless of market conditions. A simple way to do this is by setting up automatic contributions to your investment account. Contributing a fixed amount on a routine basis, such as $200 every two weeks, allows you leverage dollar-cost averaging.

Remember, automatic investing doesn’t ensure profit or protect against loss; stay committed even during market downturns.

Dollar-Cost Averaging:

This approach allows you to:

• Buy more shares when prices are lower
• Buy fewer shares when prices are higher

While dollar-cost averaging can reduce your average cost per share, it doesn’t guarantee profits or protect against losses. Consider your willingness to continue investing during declining market conditions.

Limit Updates

To reduce emotional reactions to market fluctuations, review your investments only at scheduled intervals, such as quarterly or annually. Focusing on long-term results helps minimize knee-jerk reactions to daily market changes.

Maintain Perspective

Stock market declines are part of investing. The S&P 500 Index typically dips at least 10% annually and 20% every five and a half years. However, every decline of 15%+ has been followed by recovery, with an average first-year return of 46%. While past performance isn’t indicative of future results, staying invested during downturns can lead to substantial rebounds.

Conclusion

Long-term investing offers numerous benefits, particularly through the power of compounding. Starting early, staying invested, and continuing to invest can significantly enhance your financial future. If you’re ready to start your long-term investment journey, consider incorporating these strategies to maximize your success.

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