You want to know how can investors receive compounding returns because the thought of your money exponentially growing is exciting. If you owe money and are paying compound interest on the other hand…
You know first-hand the anxiety that comes over you when you are in credit card debt and the bill comes.
Or that feeling of dread making your income based repayments on your student loans knowing you’ll be paying them for the rest of your life.
Even when you make consistent payments the balance seems to keep getting bigger.
Now you’re in a career and thinking, How can investors receive compounding returns?
If banks can do it and get away with it there has to be a way for everyone else too.
Getting compounding returns has got to be way better than my normal salary where I don’t even see half my paycheck.
What are Compounding Returns?
Before we learn how investors can receive compounding returns, let’s nail down what makes a return compounding?
Returns are compounding when they have a cumulative effect.
Like the snowball that keeps growing as it rolls downhill.
You already receive some compounding returns if you have a savings account.
If you have an annual interest rate of 1% then once a year the bank is paying you 1% of your balance into your account.
The following year you get another 1%.
This payment is a smidge higher than last year because the 1% you previously got is included in the amount when they’re figuring out how much to pay you.
The money you made is making you more money.
Einstein called it the eighth wonder of the world.
You don’t have to do anything and your account will keep growing.
That depends on your rate of interest and how long you’re willing to wait.
You can estimate the time it will take your money to double with the Rule of 72.
Rule of 72
The Rule of 72 is a reference.
It’s a quick and dirty method that you can use to figure out how long it will take for your money to double.
72 divided by interest rate = roughly number of years for an investment to double.
72/10 = 7.2 years for your investment to double
72/5 rate of return= 14.4 years to double
The Rule of 72 does make a couple of assumptions.
One is that your rate of return is constant.
The second is that after your initial investment you are sitting there doing nothing but watch your money grow.
As we will see later, the best way to take advantage of compounding returns is to really ramp it up.
The US government has a good compounding calculator that an investor can use to figure out how much they’ll make in compounding returns.
I actually like to use this calculator for a couple of things.
First is the obvious one, figuring out how much an investment will be worth 15 years from now.
The other way is to figure out your spending today.
If you go to Starbucks and get a single $5 cup of coffee a day you’re spending roughly $100 per month.
If you plug in $0 as your starting point, $100 as your monthly contribution, and even pick something low like 3% for your interest you can see how much that cup of coffee costs over time.
The number is right there, if you would’ve invested that money instead you would have an extra $14,000 in 10 years.
Doesn’t seem like a lot over 10 years so go ahead and drink your coffee. (You could make that working minimum wage for 1 year, no need to wait 10.)
But know that all your purchases really do add up quick.
Feel free to play with the compound interest calculator below and see what your spending is really costing you.
Now that we know what compound returns are, let’s discover how investors can receive compounding returns in different forms of investing.
Receiving Compounding Returns in Real Estate
When you’re buying real estate to rent it out you might think that the best thing you can do is pay all cash and collect all the profits.
It’s not a bad idea but then you’re not using the power of leverage and compounding returns.
If you have $10,000 to invest you could buy a property worth around $285,000 with an FHA loan.
They only require 3.5% down.
There aren’t many other instances where you could only pay 3.5% of the purchase price and call yourself the owner.
Paying all cash
If you have $100,000 to invest you could outright buy a rental property and collect checks.
If you’re making $10,000 a year in profit the return on your investment is 10% annually.
Plus you have a property worth at least $100,000 if you decide to sell it in the future.
Paying 10% Down
Instead of paying for the whole thing you decide to pay 10% and finance the rest.
Now you’re paying a mortgage every month which will eat a little more into your profits.
You’re still making $10,000 a year minus the additional mortgage cost.
Let’s say after it’s all said and done you’re only profit comes to $3,000 per year.
The return on your investment is 30%.
Remember you only invested 10% of your own money.
Now you have enough money to do this nine more times.
So instead of buying a single property you buy 10.
Now you’re making $30,000 a year.
Not too shabby.
And if you use some of your profit to hire a property manager, someone else will deal with the day to day.
Passive compounding returns.
How to invest in dividend stocks to receive compound returns
Investing in stocks that pay a dividend is another way that investors can receive compounding returns.
When a company makes a profit they can decide to reinvest it back into the company.
Or they can issue small payments to shareholders called dividends.
You can actually compound your ownership in a company.
Especially if you take the DGI route and DRIP.
DGI is Dividend Growth Investing.
Look for companies that have a good track record of regularly paying and increasing dividends.
When you find a business you like that annually increases their dividends buy some shares.
Every quarter or so you will get dividends based on the amount of shares you own.
If you set your account to DRIP your dividend money will automatically be used to purchase more shares in that company.
Next time your ex-dividend date rolls around you now have more shares, so you get more dividends.
And annually the company gives you a raise by raising the amount of dividend paid.
And the dividend snowball rolls down the hill and keeps growing.
It grows on its own, even if you don’t make another investment in the company again.
But It grows even faster if you make regular investments by Dollar Cost Averaging.
In 1995 Hayford Pierce was on a trip to Tahiti and did some math on the back of a napkin.
He realized if he increased the amount that he invested in dividend stocks he could eventually have enough money to live off the dividends.
He began buying shares in Altria in the late 80s and added more through the 90s.
Pierce accumulated around 11,000 shares of Altria and 11,000 shares of Philip Morris according to the Fool.
Altria’s dividend rate is currently $3.36 per share.
Philip Morris’ dividend rate is currently $4.56.
Just from investments in those 2 companies (formerly 1 company and will possibly merge again in the future) he makes $87,120 every year.
He does wish that he added more to his investments & reinvested his dividends instead of just letting them sit so he’d have even more money today.
As an investor he received enough compounding returns to make enough passive income through dividend stock investing that he doesn’t need a normal job.
Become the Bank to receive compounding returns
Another way an investor can receive compounding returns is by being the bank.
If you have cash at your disposal you can lend your money to someone looking to buy a property.
Instead of going through the bank for a mortgage you pay for the property and the person looking to buy is paying you the mortgage.
You’ll want to do your own research into the property and the buyer.
Make sure the property is cash flow positive if they are using it to generate income.
If you’re lending to a homeowner make sure they have stable incomes and can make their payments.
If they default in their payments you are the property owner instead of the bank.
Feedback Loops to find opportunities
Investors can look for feedback loops to find opportunities to receive compound returns.
You are probably wondering what in the world I’m talking about.
Let’s go over a quick example:
Walmart offers their customers the lowest prices.
Lower prices leads to more customers.
More customers means they can demand lower prices from their suppliers.
Lower prices from their suppliers means they can offer lower prices in their stores.
It becomes a self fulfilling prophecy.
You could take advantage in your own business.
If you find a keyword for an ad that is doing well:
Money in ads leads to more engagement.
More engagement leaders to more customers.
More customers leads to more money for ads.
In the rental example from earlier:
Buying a property using 10% down means you have more money for another property.
Another property means you’re collecting more rent.
More rent means you can buy another property.
Invest for long term
When you invest for the long term you increase your chances of being able to take advantage of Compounding returns.
As we learned above in the Rule of 72, it takes time for your money to double.
Since you’re investing for long term wealth and not quick gains you can afford to take chances in projects and companies you believe in.
If you think a certain company or a cryptocurrency is undervalued, you have time to wait for the price to go back up and reflect its value.
$10,000 sounds like a lot of money but in the grand scheme of things it isn’t.
You can make that back pretty quickly at a normal job.
You’ll make much more than that over your career.
Take the chance while you’re young and can afford it.
You can see that there are several answers to the question “how can an investor receive compounding returns” other than just directly compounding your money.
If you’re not ready to take the plunge to own your own business but want a piece of the compounding pie invest in real estate or Dividend Growth Stocks.
You could even find companies that are dividend growth stocks that themselves take advantage of compounding.
Like the Wal-Mart example.
There is a lot to learn when it comes to the stock market.
But you don’t have to go it alone.
That’s why I created the course How to earn $1000 through Dividend Investing.
If you’re not ready to take the financial plunge but are still interested in learning more sign up for my free Dividend Investing Bootcamp.