There’s been a bit of debate going on this week at Trader’s Bulletin HQ. It’s about what’s routinely believed to be an investor’s best friend – the ultimate power-tool in your trading cupboard.
I’m talking about reinvesting your profits.
The debate was kicked off by a trader I’ve known for a long time asking me whether I had compounded results for HAV Trading.
Much to my frustration, despite being one of the most successful long-term traders I’ve ever met, Val Harrison hasn’t been compounding his winnings. I guess it’s fair enough that a man already enjoying a very comfortable retirement is going to be more interested in spending his money than saving it.
But as a man in his 40s, with 3 kids, a mortgage and a retirement age looking further away than I’d like – compound investing is the life raft that I’m relying on to carry me to safety!
And I know that many Bulletin readers are interested in reinvesting for long-term wealth rather than collecting some extra spending money.
Which is why I sat down with Val Harrison’s trading results over the past 13 years to calculate how much he’d have made if he had reinvested his winnings. The results were very interesting.
With simple (spend it as you make it) investing, HAV Trading has turned £25k into £179,912. Not bad. But if, at the end of each year, we’d totted up our winnings and ploughed that money back into our trading account … then you’d be looking at £1,737,189.
It was a good reminder to me of just how incredibly powerful compound investing is. And what a bit of patience can do for you!
Three things you didn’t know about compound investing
1. With compound investing, a tiny difference in the percentage returns you’re getting on each trade will make a huge difference to the speed your wealth builds.
Take a look at this chart, which shows compound returns for trades earning 2%, 3% and 4%.
The 4% trade has the power to turn $100,000 into $300,000 in the space of 30 trades, while the trade with a 2% return has become $180,000 (still, not bad).
There’s a simple way to work out just how powerful compounding can be, and it’s called the “rule of 72”. All you do is divide 72 by the percentage profit you make on each trade to calculate how many winning trades it’ll take to double your money.
So, in the case of HAV Trading, where the expected profit on each trade is 5%, the answer would be 72/5 = 15 trades. (NB: this doesn’t include losing trades.)
2. Compound as often as you can. If you have a bank account that compounds your interest each month, then that’s a good thing – your balance will keep growing. However, if they compound your interest each day – your money will grow faster.
With trading, we’re at a distinct advantage in that we can compound our winnings after every trade, rather than wait until the month’s or year’s end. This means that we’re getting our winnings working for us straight away. If, in my little calculation above, I’d compounded the HAV Trading winnings in this way (rather than at the end of each year) we’d be looking a significantly more than that £1.7million figure I mentioned.
3. You don’t need to be rich to enjoy the benefits of compound investing – it is just as powerful for small sums as it is for large ones. In fact, compound investing is the perfect way to build a small fund. If you’ve £100, you can double your money just as fast with compounding as someone with £1,000,000.
Why we don’t love compounding like we should
I can wax on about the joys of compound investing all day … but, much like when my dad told me to start paying a little into my pension when I was 20 … many of us human beings just aren’t that good at delayed gratification.
Many of us turned to trading in the first place because we found that we weren’t too good at waiting! And we hoped for a “quick fix” solution. And there’s no doubt that trading can offer a “quicker” fix – but we do have to show a little patience and control.
Apparently dogs have been trained to hold a chicken-chew treat in their mouths for ten minutes, waiting to be able to exchange it for a bigger treat.
So, come on … surely we can exercise a little patience!