Everything you never learned in high school about compounded growth
Can you tell me in one sentence what compounded
growth is? And in one more sentence, why it's so important to us? If
not, five minutes from now you will.
I'm convinced if compounded growth were taught in
high school, a lot more people would be multi-millionaires. At least
every kid who wasn't high, asleep, or distracted by sex would've
learned the most important of the wealth accumulation principles.
In the 12 grade, I remember mostly sleeping through
4th period as a result of drinking beer during lunch. A buddy and I
found a bar just off campus that would serve us without ID, and that
was just so cool, if not very smart. I came within an inch of failing
English 12, which really complicated things later when I decided to
major in English at college.
Ah, yes, high school. Not only was it a time of high
anxiety, but so much of what they taught there was flat out useless. Do
you remember the early '90s TV series, Twin Peaks? If so, you might
remember the classic line Lara Flynn Boyle delivers to Sherilyn Fenn,
when these high-school girls were sneaking cigarettes in the restroom.
Boyle says, "I've been doing some investigating, and they don't use algebra in the real world."
Thank you. Just what was the purpose of geometry,
trig, and Algebra 4 anyway? Heck, I wished they had taught compounded
growth and how to balance a checkbook, instead!
Fat chance. Even today you don't have to worry that
your kids will learn anything more useful than, say, the date John
Brown raided Harper's Ferry (1859). The keepers of the curriculum just
don't think teaching compounded growth is necessary, and thus most
folks never learn that "uninterrupted compounding" accelerates the
growth of your money at a higher rate each year.
Does it really? Sure. Start with any given growth
rate and compounding will make it bigger each succeeding year. It's
like getting free money. And that's why we're going to learn it today.
Let's start with a definition of compounding: growth on your capital, plus growth on the growth of your capital.
Yes, I know, that sounds like mumbo jumbo, so let's see how it works,
starting with the Dow Double Diamond's 4-year track record for 2x
investing: 34% compounded annually.
Okay, no guarantees, but if you were to invest
$10,000 and achieve that growth rate, you'd have $13,400 at the end of
the first year. That's $3,400 profit, or 34% growth on your investment
for one year. Simple enough.
But if you were to continue earning 34%, you'd get a
higher rate than 34%, not only on subsequent years but the first one,
too. Let's do the math for three years, and you'll see what I mean.
After three years, your money grows to $24,061.
That's $14,061 profit on your original $10,000 investment. Divide by
three (for 3 years) and you get $4,687 profit per year, or 47% real
growth per year on your $10,000 investment. Not bad!
After 5 years of earning 34% annually, you'd have
$33,204 profit. Divided by 5, that's $6,640 profit per year, or 66%
real growth per year. Heck, you thought you were earning just 34% per
year. But by the fifth year, you're actually getting 66% per year, and
not for just one year, but for each one of the five years!
I told you compounding is like getting free money. Let's look at the DDD plan's 4-year record for 3x investing, which is 52% compounded annually.
No guarantees, but if you were to invest $10,000 and
achieve that rate, after 3 years you'd have $35,118, or $25,118 profit.
Divide by three (for the 3 years), and you get $8,372 profit per year.
That's 84% growth on your original investment for each one of the three
years. Impressive!
After 5 years, you'd have $81,136, or $71,136
profit. Divide by five (for 5 years), and you get $14,227 profit per
year. That's 142% profit per year on your original $10,000 investment.
Wow! And it keeps getting better...
After 7 years, you'd have $187,458, or $177,458
profit. Divide by seven (for 7 years) and you get $25,351 profit per
year, or a whopping 254% growth per year on your original investment.
And let me be clear: that's 254% growth for each one of the seven years!
Why is this so important?
Because compounding is literally the "key to
wealth." Therefore, if you want wealth, you've got to have compounded
growth working for you. And, preferably, uninterrupted compounding!
Think about it. If you knew you could potentially
get 254% growth per year on a $10,000 investment, and do it for seven
years straight, you'd be really excited about that, right? That's an
even better return than if you owned AOL and eBay shares in the late
'90s. And yet that's what you'd potentially get each year for 7 years,
if you achieved DDD's 4-year record for 3x investing, 52% compound
annual growth.
Okay, so how do you put this knowledge into action?
First, you'll want to set a wealth goal and an attainment date. Next,
you'll want to figure the compound annual growth rate you'll need to
attain your wealth goal on schedule. And then you'll want to make a DDD allocation plan that has the potential to deliver your target growth rate (for details on this procedure, use this link).
Of course, you'll need to monitor your results and,
if necessary, make adjustments to your plan to stay on track for
success. But other than that you can just sit back and let compounding
work its magic and rain free money down on you.
For uninterrupted compounding, be sure to use your
tax-deferred IRA, so your account won't be reduced by income taxes. And
remember, if you have a 401k, you can always convert it to an IRA, and
then use a broker who offers DDD trading for IRAs (although please check with your registered financial advisor first).
In closing, let me just say that I'm sorry your high
school didn't teach compounded growth, and let me also apologize for
your college, too. I won't apologize for the beer drinking that may
have kept you from your studies. But seriously, now that you know how
compounding works, you have no excuse not to teach it to your kids. And
that just might be the way to get them interested in saving and
investing, instead of indulging their every whim with a credit card
(good luck).
Until next month...good wealth building!
Sincerely,
Dick Sanders
Dick Sanders was the publisher of Dow Double
Diamond from November 2004 through January 2006. He wrote this article during
that time. Mr. Sanders is no longer affiliated with Dow Double Diamond, Tame
Trading, or affiliate companies.
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