£500 is a good sum for starting off an investment portfolio of shares. And it’s even better if that initial sum is the first of many investments made over a working lifetime. And that’s why I’m investing money monthly.
Great investors such as Warren Buffett have shown us how focusing on compounding gains from investments can potentially make us wealthy.
This is what 7% annually could do for me
For example, he’s achieved gains that annualise out at 20% a year since 1965. But I admit, keeping up the process of compounding for that long shows awesome self-discipline. Especially while achieving a meaty annualised rate as high as 20%. He’s 91 now. But I hope to retire much sooner than that.
And Buffett said in his 2020 letter to Berkshire Hathaway investors that it’s possible to achieve decent annual returns by investing passively. He reckons America’s S&P 500 index has returned an annualised 10.2% a year over that same period since 1965.
And I could invest my initial and monthly sums into a low-cost passive index tracker fund that follows the fortunes of the S&P 500. But past performance is not a reliable guide to the future. And the index may not achieve returns as high as 10.2% in the years ahead. However, I think a strong record of performance is a positive indicator that can contribute to my analysis and help me make investment decisions.
Getting into stock investing strikes me as a good idea. For example, let’s assume I can only manage an annualised return of 7%. And after the initial £500, I invest £300 each month. Punching the figures into an online compound interest calculator shows me I’d end up with a sum worth just over £1m after 45 years.
I think that’s impressive, considering the amounts invested are relatively small. But it gets better. After those 45 years, the grand total invested would be £162,500 — all the rest making up the £1m comes from those 7% annualised gains. And it all arises because of the way compounding works. Gains built on gains roll up like a big snowball and the end result can be spectacular over time.
Pursuing higher gains from individual stocks
I’d aim to increase my monthly contributions as my income rises over the years. And that way, the final spending power of my investment pot will likely keep up with the eroding effects of general price inflation.
But I’d do something else as well. In an effort to increase the value of the end sum, I’d aim for higher annualised returns by investing in individual stocks and shares. Of course, it takes more research and monitoring effort than simple index-tracker investing. But that’s how Buffett achieved his higher gains.
And small changes in the rate of annual return can compound up to a big change in the end sum. For example, with the same sums invested as described above, if the annualised return increased to 10% instead of 7%, the end sum after 45 years would be around £2.7m. That’s almost three times higher for just 3% more each year!
However, nothing is certain or guaranteed in the world of stock investing. Nevertheless, to me, the potential gains are worth the risks of aiming to pick my own stocks.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.