Compounding Returns: Magical, Powerful And Too Often Ignored

Jan 24, 2017

You’ve probably heard about it before, the magical, cosmic power of compounded income over long periods of time can result in some astonishing returns, if only you had the persistence and patience to see your plan through. For example, $10,000 invested and reinvested for 30 years at a consistent 4% annual return can grow to $32,433.98; a net compounded return of 7.46% annually from a stated return of only 4%. Had you taken out the income each year, the total return including your original investment would have been a total of only $22,000; a net difference of some 87%.

But who has the time and patience to wait 30 years to realize the benefits of compounded interest? Not you, I’ll wager. So how do investors in our short term oriented “I want it right now” world take advantage of the long term magic of compounding income? 

There is a way; but it involves critical thinking, some measured risk taking and the perseverance to follow through with a rational plan.

The first part of a plan that can take advantage of long term compounding of returns requires a sound investment foundation that can yield an acceptable rate of return, which in this example is a portfolio of blue chip quality dividend paying stocks. Assume a modest 3% income return, and assume for the time being the portfolio does not grow in value, it only pays 3% in dividends. The way the 3% is reinvested is where accelerated returns can be found.   

Instead of investing your 3% dividend return in the same asset class that is paying it, you invest the 3% in high quality growth assets. You may notice I continue to refer to “high quality” when citing investment selection. Anything less than best quality can blow up your investment plan at any time, so stick with the best, you won’t be sorry.

Growth is the key when compounding returns over time. In only four years, your measly 3% dividends has spun off a total of 12% of your original invested sum, which can grow like crazy once you keep investing your income into high end growth. Some examples of growth investments can be in the best of breed mutual fund arena, or in top flight growth companies like Amazon, Alphabet (Google), Amgen and several others. These investments can be volatile, but their price changes can offer ideal entry points for the cold-blooded, rational investor who buys them when others are running for the hills. Disciplined asset selection is key; chasing hot names and trendy investment fads can prove financially fatal.  

After a period of seven years, your reinvested growth component, paid for entirely by dividend income can equal 50% or more of your original investment, resulting in returns of 8% or perhaps a lot more. After 10-12 years (or maybe less), the value of your growth assets may exceed the original foundation investment paying your dividends, a result of more than 100%.

Of course, periodic market crashes, financial upheavals and other hazards can always derail a plan like this one, but many past financial calamities tended to be transient, and have proven to be exceptional opportunities for the cool headed investor. In times of severe financial disruptions, the blue chip dividend paying foundation of your plan can offer a safe harbor until the financial storm passes.

If interest rates for bank deposits and bonds ever rise to more normal levels of around 3% or more, compounding of income can get easier and big returns can be realized in shorter time frames.

A highly developed and evolved version of the plan described above can be acquired through our exclusive Dividend Power® investment program; contact us at Kensington A.M.I. for details.