Have you ever wondered what makes a person a good investor? The answer may surprise you. The news coverage of the financial markets make it seem like you need to use complicated strategies and stay up-to-the-minute on market movements to have any hope of investing success, but – despite all the hype – there is no demonstrated correlation between a strategy's complexity or the amount of time spent studying markets and actual results.
The best ways to become a truly world-class investor are so simple that they seem hard to believe. But they work because of a powerful mathematical concept that is tough for our brains to understand: compounding returns.
Our minds evolved in a world where linear decisions determined survival – how fast you can run, how much you can carry, how much food can you hunt or grow, etc. There's a linear relationship between effort and result: running fast is important to avoid being eaten by a wild animal but, no matter how hard you train, you can only increase your speed so much before you max out.
Compounding, on the other hand, is exponential. Have you ever seen footage of bacteria dividing? That's an example of exponential growth. At first there is only 1, then 2, then 4, then 8, and before long there are so many bacteria that you can't count them all. That kind of growth is hard for our brains to understand, but it's how a disciplined investor can achieve life-changing investment returns.
When you invest your money – and keep it invested – past gains can continue to grow and grow and grow until the returns become hard to fathom. Here's an example: at the average stock market return rate of 10%, your money should double about every 7-ish years. So if you invest $1,000 in a low-cost S&P 500 index fund, that investment should be worth $2,000 in around 7 years (a 100% return), $4,000 in 14 years (a 300% return), $8,000 in 21 years (a 700% return), $16,000 in 28 years (a 1,500% return), etc., etc. With each successive doubling, the growth becomes so much larger than the initial investment.
Unlocking that kind of exponential growth is exactly how ordinary people can build wealth by saving & investing over years and decades. And you don't need to be a finance expert to understand how to do it! Below are four simple tips to make you a world-class investor:
Choose a strategy that lines up with your long-term goals. A good investment strategy isn't one that works for the next quarter or the next year; it's one that works for the next decade or quarter century – or the rest of your life. Your investment plan should have the short-term volatility of the stock market built in, so that the ups & downs that every investor faces are just like speed bumps on a much longer journey.
Buy investments that you could own for the rest of your life. Compounding only works if it is allowed to happen uninterrupted so, in order to fully enjoy the benefits of compounding growth, you need to own the same things for a really long time. Instead of following current investment trends, aim to buy holdings that you could theoretically own the rest of your life. A good example of this is a low-cost fund that tracks a specific index like the S&P 500: the individual stocks within the index will change over time, but your ownership of the fund can remain consistent.
Keep adding money to your investment accounts in good markets & bad. Despite what you see in the media, absolutely no one knows when the next bear market or recession will start. Trying to "time the market" – buying or selling based on predictions about what the markets will do – is a fool's errand (though lots of fools attempt it). Since there's no way to know whether today is a better or worse day to invest than tomorrow or next week or a month from now, we can be better investors simply by removing timing from our decisions. Whether you add the same amount with every paycheck or choose to add money whenever you have extra cash, consistently contributing to your investment accounts is an excellent way to build wealth through good times and bad.
Do as little else as possible to interrupt steps 1-3. Remember that compounding only works if it happens uninterrupted for a very long time. While you may need to adjust your overall allocation (the mix of stocks, bonds, and cash that's right for you) over time, most changes should be few and far between.
What do you think – could you follow those principles? It takes time to see the benefits of compounding, but with a few simple guidelines and some patience, those 4 simple tips should help you become a truly great investor.
Want to review your investment strategy? Send me an email or schedule a quick intro call to start a low-pressure conversation.
Thanks,
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
Iseler Financial helps creative professionals remove stress while taking control of their financial lives. We'll help identify your current strengths and weaknesses, clarify and refine your long-term goals, and prioritize decisions to improve your financial well-being now and later. Reach out today to take the first step.
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