The benefits of compounding

As a hedge fund firm we consistently achieve a double-digit ROI. At Firstconinvest is ROI not only a performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments.

One of the main reasons new investors lose money is because they chase after unrealistic rates of return on their investments, whether they are buying stocks, bonds, mutual funds or real estate. This happens due to a lack of experience. Most folks just don’t understand how compounding works. Every increase in percentage profit each year means huge increases in your ultimate net worth. For example, $10,000 investing at 10% for 100 years turns into $137.8 million. The same $10,000 invested at only twice the rate of return, 20%, turns into $828.2 billion. It seems counter-intuitive that the difference between a 10% return and a 20% return is 6,010x as much money.

Answering what is a “good” rate of return on your investments is probably easiest if we examine the nearly 200 years of data from Ibbotson & Associates, a data research firm that tracks financial market history. The first thing we need to do is strip out inflation. The reality is, investors are interested in increasing their purchasing power. That is, they don't care about “dollars” or “yen” per se, they care about how many cheeseburgers, cars, pianos, computers, or pairs of shoes they can purchase.

If you expect to earn 15% or 20% compounded on your blue chip stock investments over decades, you are delusional. It isn't going to happen. Basing your financial foundation on bad assumptions means you will either do something stupid by overreaching in risky assets or arrive at your retirement with far less money than you anticipated. Neither is a good outcome so keep your return assumptions conservative and you should have a much less stressful investing experience.

We remain on Real Estate – Without using any debt, real estate return demands from investors mirror those of business ownership and stocks. The real rate of return for good, non-leveraged properties is roughly 7% after inflation. Since we have gone through decades of 3% inflation, over the past 20 years, that figure has stabilized at 10%. Riskier projects require higher rates of return. Plus, real estate investors are known for using mortgages, which are a form of leverage, to increase the return on their investment.