Compound Interest – Key to Successful Investing

Investing is by no means an easy task and it is one that involves many stressful ups and an downs.  For the average non professional investor, these ups and downs can be overwhelming, while the professional sees them as just daily market volatility.  So, no matter what you do as an investor, you will see your investments raise in price and go lower in price.  There just isn’t any way to avoid market volatility as an investor.  But, what we can do as investors is to work on a very important cornerstone of investing, and that is compounding.

Compounding is most often described as “compound interest” (Wikipedia and compound interest), other people simply describe it as compounding.

What is compound interest?

Simply put, compound interest is a process where an investor can earn interest at an increasing rate as the cash returned from the investment is reinvested back into the investment portfolio.  Let’s look at an example:

Initial Capital = $100
Interest Rate = 5%
Interest after 1 year = $5
Total Capital after 1 year is $105

Here is the compounding part so watch closely !!!  As you see below the interest for the second year is off a newly higher base of $105 dollars.

Capital at beginning of year 2 = 105
Interest Rate = 5% (unchanged)
Interest for year 2 = $5.25
Total capital after year 2 = 110.25

So, the extra boost from compounding is $.25.   Yes, yes, I know compounding isn’t a get rich quick gimmick…nor is it a bitcoin strategy.  Instead compounding is a slow and methodical way to boost your investments over time.  The example I used is very simple and using small numbers.  But when extrapolated over 10-20 years the true power of compounding can be shown.   You can jump over to Investor.gov to see their compounding calculator.

I just did a quick compounding of
Initial investment of $100,000, @5%interest, and $100 month contribution, for 20 years.  and the total grows to $305,009.  There are a number of variables at work here, so you can jump over there to run your own example.  But the important concept here to take away is to fully understand that you want the base of your investments to grow over time, and to grow and an increasing rate.  If you were to not add the $100 contribution each month, and you removed the 5% interest each period to spend it, then you’d still just have $100k at the end of 20 years.

The point here is to put your money to work, and then allow it go grow upon itself to boost the value of your portfolio.  As you can see above, this won’t happen over night, but instead in a consistent and steady way.

Invest in Single Family Real Estate

When you have extra wealth or savings it’s best to think of ways that you can invest those funds.  The reason that you want to invest is to earn a return on the money that you have saved.  It is an easy way to think about having extra money.  Once you have some disposable income or extra cash, you’ll have to start making decisions about what to do with that extra money.  There are a lot of investment options that you have:

  1. Invest in stocks or equity
  2. Invest in corporate bonds, high yield bonds, government bonds
  3. Invest in international bonds & stocks
  4. Invest in commodities, currencies, derivatives, options, etc.
  5. OR you can invest in real estate

So, I know what you are thinking…how do we decide what to invest in?  Well this isn’t an easy answer, and definitely not an answer that be be answered in a blanket response to all readers.  Deciding what to invest in is a person specific response that will be based on many factors that include: risk tolerance, return profile, taxes, timeline, liquidity needs, and any legal issues.  To delve into all of these issues, is really a book and not a post.  BUT, don’t fret we cover most of those issues on this website and much, much more.  The goal of this website is to be a hub of information for our readers learn more about how to grow their assets, earn more income, and to have a more profitable and enjoyable life.

So, when you think about investing into real estate there are some common traits shared by these type of investments.  First, real estate is thought to be a relatively stable form of investing.  Second, even though real estate can drop significantly in value, it is commonly thought that real estate will raise 5% in value on average, compared to a historical increase in the stock market of approximately 8%.  For this extra return in the stock market, the investor will take on more risk and uncertain in the return that is earned.

How much house can you afford?

You can easily find out how much house you can afford by using an online mortgage affordability calculator like the one provided by Bankrate.com.  Once you check out the bank rate calculator, you’ll have a better idea about wether or not you should be investing in a single family home.

Do you own a Single Family Home or Rent?

The math used in this decision is based on whether you are using this house as a place to live or for our family, or will this house be strictly an investment property?  There are a lot of people who feel that they must own a home no matter what, and therefore the decision to buy or not for a first home is affected by many behavioral or psychological preferences.

What is the Purpose of Wanting to Buy a Home?

If you want to buy a home for an investment or for living?  Do you feel that owning a home is essential goal or necessity for you to have in order to feel your life is complete?  I know a friend who feels that in order to feel like a provider for his family…he must own a home.  So in his case, he would choose to own a home, if it meant that this was his only form of investment for his savings.

What is right for you?  Please comment down below.

I’d love to hear your thoughts about what you feel about investing into a new home.  I know that there are calculations that can be done that would prove mathematically what you should do regarding buying a single family home…but maybe that is not the right answer for you.