Part 1. Investing basics: Introduction to investing

The story about riches and how to invest and gain significant wealth over long period of time.

PART 1. SNOWBALL EFFECT

“J.F. Kennedy alley, Monaco. I am watching big white yachts floating on the light blue Mediterranean Sea with wealthy owners keeping themselves busy on these. I am sitting outside in the cafe on a sunny September morning with the nicely smelling Café Noisette in front of me. I am looking around and I am again convinced that most of the people spending their time here are elderly. They are considerably older than me, originating from the United States of America, Great Britain and Germany. I have been everywhere in Europe and I have noticed the same trend in Rome, London, Nice and elsewhere and especially here, in Monaco. Such attractive places are loved by wealthy people, but what is the source of their wealth? Is it pension, heritage or lottery jackpot? And why are they mostly elderly people?

I think I know the answer. The secret of these people is time and investing. These people have become wealthy by investing and as they are old, they have probably done it for their whole life. Time and investment give money a cumulative return. This results in considerable growth of wealth.”

Albert Einstein has called cumulative return the biggest mathematical discovery of all times.

What is cumulative return?

The constantly invested money grows in geometrical progression: 1,  2,  4,  8,  16,  32,  64 etc. But let us look closer. Lets imagine. What will be your choice, if you are given one following?

  1. ONE MILLION US Dollars to your possession on 1 January, or possibility to
  2. INVEST 1 CENT on for one month with the daily rate of return of 100%?

The beginners who have not been involved in investing would choose 1 million “cash now”. They might also promptly think about spending it because 1 million USD is a very large amount of money. But the experienced investors would choose another option, as 1 cent as invested is actually much bigger. How could it be possible?

Lets calculate the growth in value of 1-cent investment and start from January 1st.:

1 cent has become 5.12 dollars by 10 January. But the majority of the month is still ahead and our money continues growing every day. You are thinking that although 5 dollars received for 10 days is very little and if you had received 1 million dollars on the first day, you would be much happier. But wait, time works to our advantage.

1 cent has become 5 242.88 USD by 20 January. And 11 days have remained. The sum is still very small, but let us see what comes next.

1 cent has become 83 886.08 USD by 24 January which is already quite considerable amount. Only one week is left to wait. At last it is last day of January and here it is:

By the daily rate of return of 100%

1 cent becomes 10 MILLION dollars

with one month!

You are surprised? I am not. Although 100 % daily rate of return is not achievable in real life, this example illustrated vividly how people become wealthy by investing.

Back to reality

Although 1 cent seems too little as a starting point and 100% rate of return clearly impossible, we will look at the slightly more real example. We will take 10 000 dollars as a starting point and what if we receive little more each year. To compare we choose 5%, 10%, 12% and 20% annual return and this sum adds each year to our initial investment and see what happens to your sum when it is invested for 10, 20, 30 or 40 years.

Seems unlikely? No, these are already quite real numbers.

It is not important what the initial amount to be invested is, but the fact that you start investing TODAY!

By starting regular investing now in small sums and by continuing this for long time, your money starts to grow at an increasing pace. Investing in small amounts is comfortable and, inter alia, with quite a low risk.

Investing in small amounts

So, if you decide to invest 100 USD a month, what will be your financial status in following years. As shown in the table below, your wealth increases quite nicely with years.

For comparison, bank deposits increase your money by 1% or 2 % a year, bonds about 3%-7% a year, the historical average rate of return of stock markets has been about 12% a year. This growth with 12% every year is quite a good increase? And even real estate and gold do not provide competition to the rate of return of stock markets.

Thus, if share markets provide 12% as the average annual rate of return, it should be achievable for everyone. Yes, it is!

TIP! RULE 72: If you wish to calculate the number of years within which your
assets double, the rule 72 contributes to the calculation. By 12% annual rate 
of return  your invested sum would double in every 6 years. 2 times means hundred
percent (100%). 72 / 12 = 6 means that 10,000 USD becomes 20,000 USD with six 
years. The sum increases to 40,000 USD in 12 years and to 80,000 USD in 18 years. 
Just as a snowball which continues to grow.

The average annual rate of return of stock markets

What is the annual rate of return? In simplistic terms, one should take the price of all tradable shares at the stock market at the beginning and at the end of the year and calculate the decrease or increase in price within this period. 12% average annual rate of return thus means that the prices of shares have annually increased by 12% within the last, e.g. 75 years.

Attention! As mentioned earlier, if your investment portfolio grows every year, investment increases in geometrical progression (pace). Thus the most successful years with rapid growth are the last years of growth. As our lifetime in this world is limited, this is just the reason you should start today – to participate in the growth of investment which takes place in the last decades of our life.

So, the ones starting investing at the age of 20 or 30, could enjoy considerably higher wealth than the ones who start at the age of 40 or 50. It is important to start today!

“I am taking a sip of my splendid coffee being convinced that this is the secret of these people who spend their wonderful time here in Monaco, keeping themselves busy on their boats.”

Next: Part 2: Achieving adequate rate of return »