Time could help regular-savings-plan investors chalk up a considerable sum of returns.
Clearly, the initial investment sum plays an important role in the sum of returns. Let's say you invest $100,000, assuming an investment return of 20%, you would get $120,000 in total. The sum would diminish to $12,000 if you had invested only $10,000 at the same rate of return. So some people may have an illusion that investment only work well for people who invest large sums of money.
Well, not exactly. Even if you invest a relatively smaller amount, you could make a very good return by utilising the power of compounding. What you need to have on your side is TIME; or simply to invest early. Let's illustrate how much $100,000 would grow at steady rates of return over different periods as shown in Table 1.
Assuming a long term rate of 2% per annum, the initial amount of $100,000 would grow to $ 122,000 in 10 years, and $181,000 in 30 years' time. However, if you chose to just invest into fixed deposits at this point of time, you would probably expect a lower rate to be used for compounding. The current fixed deposit rates from three largest local bank ranges from 1.4% to 1.5% per annum as at 20 February 2008. If you chose to invest in a diversified balanced portfolio with a 40% weighting in fixed income funds and 60% weighting in global equity funds, you would probably expect returns from 5% to 7% per annum over the longer term.
Thus, if an investor chose to invest in a diversified portfolio with an average rate of return of 7%, the investment could grow at a faster pace. Assuming a rate of return of 7%, in 10 years, the investment will grow to $197,000 and to $761,100 in 30 years' time.
You may wonder, "What if I am good at building an aggressive equity portfolio and I invest early?" Assuming an annualised return of 12% - in 10-year's time you would have made $311,000, which is 3.1 times of the original investment amount. The sum balloons to almost 30 times the original amount in the span of 30 years. A great value investor like Warren Buffet generated annualised returns of 21.4% in the past 42 years (since 1966). With the power of compounding, the investment grew tremendously to 336 times the original amount in 30 years.
Table 1: Investment returns of $100,000 at different annualised rates
The table above illustrates that fixed deposit may look safe but would entail substantial "opportunity cost" of giving up investment. As long as you invest early and pick the right asset class or portfolio, even a decent annualised return of 7% would bring you a long way. Investing for the long term also helps investors to tide over short-term volatility in equity markets. Long-term value investors are less-likely to exhibit too much fear during volatile times unlike many ordinary stock investors who just look into momentum investing.
Other than investing a lump sum for the long term, investors may also choose to invest regularly by using the Regular Savings Plan. This investment strategy is suitable for long-term investors to make use of the power of compounding.
Kelvin Yip (Assistant Research Manager & Financial Adviser Representative) is part of the Research and Editorial team at Fundsupermart.com, a division of iFAST Financial Pte Ltd.
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