Not all heroes wear capes! When it comes to investment strategies, there are saviours hiding in plain sight. Like the characters of science fiction, these approaches to investing have superhero powers that can maximise returns and help you meet your financial goals.
Compound investing is an important ‘hero’ to have at your disposal. Its remarkable effect reputedly led Albert Einstein to refer to it as ‘eighth wonder of the world’ as it can accelerate the growth of your savings and investments over time. It’s the gradual but potent effect of getting returns on your money and then returns on your returns.
For instance, say you have £1,000 and you earn a 5% annual investment return after charges. In the first year, you would grow your investment by £50, giving you a new value of £1,050. In year two, you would earn 5% on the larger balance of £1,050, which is £52.50—giving you a new balance of £1,102.50 at the end of the second year.
Thanks to the magic of compounding, growth accelerates over time as you earn returns on increasingly larger amounts. In this example, after 30 years the original £1,000 would have grown to £4,321.94 without a penny added.
Making a profit consistently is easier said than done of course, and when investing negative periods are inevitable. All investments can fall as well as rise in value, and investors may get back less than invested. A really big loss can be hard, if not impossible, to recover from, which is why taking a sensible amount of risk to avoid this investment ‘Kryptonite’ is important. That won’t mean losses are eliminated but it should limit the downside. To sum up, compounding is a ‘slow and steady’ investment approach that’ll keep working given enough time.
The ‘cost of living’ crisis has led many of us to ask: ‘is it a good time to invest?’ When compound interest and time join forces, they can defeat the nemesis that is inflation – rises in the cost of living over time. The longer period you invest for, the more powerful compounding becomes; as returns snowball faster the longer your money is invested.
A longer time horizon also increases your ability to take risk and harness higher returns. For those focussed on shorter time periods, near-term market movements are of importance and can be a worry. This is why people with shorter horizons need to have more ‘balancing’ assets in their portfolio strategy, to dilute the large ups and downs that share markets inevitably provide.
For those able to ‘zoom out’ these tend to look a lot less significant. If you are saving for retirement, which can be decades away, then the shorter term ‘noise’ is of less consequence, bumps in the road in what is a long journey.
3. Pound cost averaging
By investing monthly in chunks, rather than a larger lump sum in one go, an investor ends up buying more shares or units when prices become cheaper and fewer when they become more expensive. This superhero of an investment strategy is known as pound cost averaging and deploying it can be highly beneficial.
That’s because if you keep buying the market falls you could, over time, vanquish the foe of market volatility to smooth returns, and even turn it to your advantage; though there are still risks. As with all investments, you could get back less than you put in.
For example, if you invest £100 every month into a fund, the cost of the units for each purchase will depend on how the assets in the fund have performed. For example, if in month one units cost 50p each you would get 200 units for £100 invested. If in the second month they are 54p each you would get 185 units for the same amount of money, but if they dip to 40p you would get 250 units.
Pound cost averaging is one of the types of investing that works best over long periods. But even if you don't have a multi-decade time horizon, it's still possible to build up a significant sum by saving regularly.
Dividends are the distribution of profits a company makes to its shareholders. If you own shares in a company that declares a dividend, you receive a slice of that money. This investing trick might not seem that exciting to get a small percentage each year from shares you hold, but don’t let that humble Clark Kent exterior fool you.
This investing hero can form a substantial chunk of returns over the longer term and supercharge returns if you reinvest and buy more. For instance, the US S&P 500 index has turned £1,000 into £3,669 in capital growth terms over the past ten years, but with income reinvested that rises to £4,209.
For the higher yielding FTSE 100 in the UK, dividends have been even more vital. As the chart below demonstrates, the ten year capital growth has increased a £1,000 investment to £1,287 and with reinvested dividends it is £1,879.
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