By Ethan Currie, Staff Writer
Albert Einstein once said, “compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” Despite the lack of excitement that traditional index fund or exchange-traded fund (ETF) investing shows, the results can be anything but boring. The best way to ensure consistent investment returns over a long-term horizon is to do three things: invest early, invest regularly, and stay invested.
Investing early is the key to capitalizing on compound growth. Unfortunately, Canadians rarely take full advantage of their time. Starting to invest as early as possible has a huge impact on returns, especially when looking through a long-term, or retirement-oriented lens. Demonstrating this concept is quite simple. If an individual were to invest $10,000 at the age of 20, at a 7% annual return, in a tax-sheltered vehicle such as an RRSP or a TFSA, and withdraw the funds at their retirement age of 60, they would have $149,744.58. Alternatively, if they invested $30,000 at the age of 40, with the same 7% return and withdrawal at the age of 60, they would retire with $116,090.53, despite a deposit three times the size. Although the best time to plant a tree was yesterday, the second-best time is today.
Investing regularly is another great way to grow your assets, through the concept of dollar cost averaging. Regular contributions to investment accounts not only function as a way to maximize an individual’s returns, but they’re a great way to ensure consistent financial budgeting. Investing a lump sum of money at one time exposes an individual to market volatility in the short-run, and can also have a negative impact on returns over a longer period. However, by regularly buying into an ETF that tracks a broad market index (e.g., the S&P 500), investors can eliminate some of this risk. For example, purchasing 50 shares of a stock at $100 per share, and an additional 50 shares of the same stock at $110 per share provides more value than purchasing a lump 100 shares at the $110 mark ($105 average price vs $110). Dollar cost averaging allows investors to purchase when securities are ‘on sale’ and encourages a positive behavioral approach in personalized money management.
Staying invested can be challenging to say the least. The constant volatility in the markets, combined with financial news and advice that is becoming more prominent through social media both contributes to hesitations and rushed decision-making. Attempting to time the market to invest accordingly is not a sustainable strategy. In fact, historical statistics show that those who stay invested usually benefit to a greater extent than those who continually buy and sell securities. To put this into perspective, the S&P 500 index has had an annualized performance of 5.62% over the past couple of decades. A $10,000 investment at the beginning of 1999 would have grown to approximately $29,845 by the end of 2018 at this rate. However, this assumes that the initial investment had stayed invested. If an investor were to miss just the 10 best performing days of the market, the annualized performance would only be 2.01%, over the same 20-year period, yielding a $14,950 deficit compared to the “set it and forget it” approach. In the same way, missing 20 of the best days over the 20 years would result in a -0.33% annualized return, turning the initial $10,000 into $9,359. Investing rewards patience, and time in the market will almost always outperform attempts to time the market.
Consistent and conservative approaches will typically pay dividends (both literally, and figuratively). Like many things in life, a flashy approach may not always be the most reliable way to get the job done. Results do not often have a shortcut – like seeing progress in your physical health, or achieving great marks in school – these things take consistency, despite a natural human urge to eliminate the time gap between the start, and the end goal. Investing your wealth is no different. In a social media-consumed world, it can be tempting to pursue the rash trading strategies that are boasted about frequently. Ensuring that you are capitalizing on great market returns, while simultaneously mitigating your financial risk can be accomplished through the compounding ability of an index fund portfolio. There is a power in “boring” investing. Dependability can go a long way to ensure success and security, especially in a financial regard.
Photo by Joshua Mayo on Unsplash