These Three Investing Rules Can Make You Rich

Wall Street would have us believe that investing is difficult and that planning for our financial futures can only be properly done with the assistance of a high priced investment advisor and sophisticated investment products that most of us don’t understand.

In reality, however, nothing can be further from the truth.  The use of a couple of well documented investment “rules” that most of us already understand can see our financial futures set, assuming we make our finances and investing a priority in our lives.

These three rules cut through all the “noise” of the investment world and make saving and investing simple.  These rules are not new, and there is nothing glamorous or flashy about them.  But commit to them, and they will work for you.

Compounding simple refers to saving a little, often, and reinvesting the earnings.  For a miracle of compounding investment plan to be successful, you need two things: 

Time

 See the miracle of compounding table here to see how an investment of $16,000 grows into $1,000,000.  The table also shows the effect of delaying your investment by just six years.  How much more do you think you would need to invest to achieve the same $1,000,000 outcome?

Persistence

All the time in the world won’t make an iota of difference if you can’t commit to starting and continuing your savings or investment plan. 

During the early years of a miracle of compounding investment plan you need persistence to keep going. The results over the first 7 years are less than spectacular.  Depending on the rate of return you achieve however, after the first 7 years you can start to see your investment spinning out more cash each year than you contribute.  

This can have two effects.  For some of us it can motivate us to keep going.  This is what you want to happen. However, it can also be tempting to dip into the investment for some luxuries.  Withdrawing funds from a miracle of compounding investment plan, especially in the earlier years, seriously erodes the final outcome.

The Rule of 72 makes calculating investment returns quick and easy without a calculator, showing how the rate of return (interest rate, dividend rate etc) can greatly impact and investment outcome.

The Rule of 72 says you can calculate the time it takes to for an investment to double but dividing 72 by the interest rate on the investment.

For example:  If I have $1000 invested in a high yield bank account at 6% it will take 12 years
for my $1000 to double to $2000.  That is, 72 divided by 6 = 12.

The Rule of 72 shows what a large impact the interest rate you earn can have on your investment.

Our third investment rule, Dollar Cost Averaging, is designed to take the stress out of trying to time the market. Trying to find the perfect entry point into the stock market can be stressful and costly if you miss in your estimation.

So, Dollar Cost Averaging uses the same assumption as the Miracle of Compounding – invest a little often (at the prevailing market price) instead of investing one large sum at a single price.

Investing small amounts, say monthly, allows you to average the price at which you purchase your stock.  One month your $100 will buy 10 shares (assuming a price of $10 per share) and the next it may only buy 9 if the price has gone up to $11 per share. 

But the power of dollar cost averaging is in the averaging.  At the end of the second month, with the current share price at $11, your average cost is only $10.50.  That is $200 (total invested) divided by 19 (the total number of shares purchased).