Compounding, or exponential growth as a mathematician would call it, is one of the most important facets of investing that every investor should understand – in depth.
Attached is a chart showing the results that compounding can accomplish. The rule of 72's is an interesting rule. Mathematically, 72 divided by a rate of return shows how many years for an investment to double.
At one extreme, a one percent return will take 72 years to double the size of an investment (72/1)! I don’t know about you, but waiting for a lifetime isn’t on my agenda. A ten percent return will double in 7.2 years(72/10) and a twenty percent return will double in 3.6 years (72/20). That's just simple mathematics.
In order to obtain the "doubling", the investment return must be sustained over the time period. The bigger the rate of return needed over a period of time, the less likely it is realizable.
Take a look at the attached chart and determine where you are at. You don't want a one percent return since it will take almost the average life span of a human to double - 72 years. Trying to get a twenty percent return isn't likely to happen either.
The point is you don't want to error on too low a return or too high a return. A low return will take a lifetime to double. While a high return risks losing the investment, not just losing the return. The sweet spot is somewhere in between.
Being too conservative or aggressive both have their downfalls. Like all things in life, the answer lies somewhere in between. What is the right decision? Only each individual investor can answer that question, but they sure better understand it.
Take a few minutes to understand the attached chart and you will be much better for it.
Be well read, be smart and be successful!
