7 Rules For Investing - Appreciate the value of compounding – Rule 2

Appreciate the value of compounding

Compounding can be a very powerful strategy. In simple terms, by leaving any returns (gains) within your investment it is possible to then gain any potential returns on the additional funds as well. This can then have an even greater effect if you make small regular contributions to your investment.

Case Study: Regular Saving Plan

Fiona, John and Simone all decided to invest $10,000 in the same fund for 10 years. Over the 10 years the fund earned an average of 8% per annum. Fiona made no further contributions. John contributed another $100 a month and Simone added an extra $200 per month.

The change in results is dramatic.

Initial Monthly Average Value after

investment contribution annual return 10 years

Fiona $10,000 $0 8% pa $21,589

John $10,000 $100 8% pa $39,602

Simone $10,000 $200 8%pa $57,614

Dollar Cost Averaging

By investing regular amounts over time you can also take advantage of Dollar Cost Averaging. This is based on the one outright certainty about share markets: the price of shares go up and down.

With Dollar Cost Averaging you invest an amount on a regular basis irrespective of what the unit price of your fund is. Over time this can smooth out the instabilities of the market and is one way of decreasing your overall risk.

Source:Colonial First State

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