The Dynamic Duo: Compounding Returns and the Time Value of Money
by Steve Gail
In the past few months, The Drip Advisor has emphasized various topics as basic as, "What is a DRIP", Record Keeping for DRIP transactions and a lot of topics in between. Today, I would like to discuss a topic that is universal in importance to DRIP buyers as a whole, but is even more advantageous to younger DRIP buyers. The topic is called Compounding Returns and the Time Value of Money.
There is a time when it becomes apparent that you become very aware of time. You will start saying things like," Where did the time go" or "I sure wish I'd would have had more time." Well, the point that I am trying to make here is that your investment philosophy needs to take on that same awareness. To give you an example of just how important time is in regards to your money, I want to give you several scenarios in regards to three different investment situations each being affected by time along with rate of return.
EXHIBIT A: (Below): $50 start-up investment with $50 added every month from Auto option cash program compounded for 20 years.
Notice the difference between 4%, 8% and 12% returns annually are
significant just from the rate of return alone, however; notice how the difference between all three (3) return rates continues to grow significantly the longer the investment is maintained. The important concept here to understand is, although the rate of return may look like the variable that is most responsible for the difference in the return. It is actually the period of Time that the investment is held for, that ultimately makes the difference in all three scenarios.
To better demonstrate to you this concept, please examine the same information from the chart above in the graph from below.
EXHIBIT B: EFFECT OF TIME ON COMPOUNDING RETURNS
Notice it is in the last 5 years of the 20 year frame horizon, that the real growth of the investments start to materialize. The majority of the growth, no matter what the compounded return may be, still comes from the last 5 years of TIME. Also notice, the greater the compounded rate of return, the greater the increase in the overall investment return. But do not lose site of the fact that the spurt in the growth of the investment is augmented by THE AMOUNT OF TIME the investment is held and left to compound. THE LONGER THE TIME and the greater the return the greater the growth lines as the investments diverge. So if they is one lesson the a DRIP investor should learn from this example. THE EARLIER ONE STARTS HIS INVESTMENT PROGRAM, THE GREATER HE HAS TO MAXIMIZE GROWTH BECAUSE OF THE FACTOR OF TIME .
Ponder that thought, over and over again. Sleep on it tonight
As I leave you.
Until Next Time,