If you’re a small investor, you may have learned that many financial advisers don’t want your money. It’s common in the business to see minimum account sizes that are well beyond the means of small investors. While there are advisers with account minimums of $1 million or more, some investors are starting with less than $25,000.
It might be frustrating to find that many financial professionals want nothing to do with small investors. But, sometimes advisers give meaningless advice, even to investors that meet their account minimums.
Many advisers will spend a great deal of time talking about the long run. They like to explain that with enough time, anyone can enjoy a financially secure retirement. For example, if you invest $200 a month every month for 40 years, your account will be worth $1.2 million if stocks gain an average of 10% a year.
The math behind that calculation is correct but there are two big problems with this advice for investors who are limited to existing in the real world. The first problem is that most of us don’t have 40 years before retirement. The second problem is that those with 40 years until retirement, young people in their 20s or 30s, don’t have money to invest for the future when they face bills like rent or student loan payments every month.
The later an investor starts saving, the less they will have at retirement.
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But, the idea of small investments growing to a large amount of money is appealing. Unfortunately, none of us have a time machine that would allow us to go back in time and create that small account when we were young.
Now, this might seem to be a contradiction, but because the math financial advisers use is correct, no investor’s situation is completely hopeless.
Those dramatic increases in wealth over time are due to the principle of compound interest. According to a popular legend in the financial adviser community, Albert Einstein supposedly called compound interest the “eighth wonder of the world.” In some stories about Einstein, he called compound interest the “greatest invention of mankind.”
Now, in all likelihood, Einstein probably never said anything about compound interest. But, also in all likelihood, compound interest is the key to wealth accumulation for many individual investors.
Compound interest is relatively simple to understand. If you invest $100 and earn 10% a year, after one year you have $110 which includes the original $100 plus $10 in interest. This assumes the interest payment is made at the end of the year.
If you decide to keep all of the funds in your account the next year, you will make $11 since you earn 10% on $110. At the end of the second year you have $121 and at the end of the third year with 10% interest you have $133.10. These amounts assume you earn interest on the interest payments.
With simple interest, if you earn a straight 10% return every year you would only have $130 after three years. This might not sound like much of a difference but over time, these small differences add up. In 25 years, with compound interest $100 would grow to $1,083. Without compounding, the account would only be worth $350.
Great investors take advantage of compound interest but the world’s greatest investors really are different than average investors. At the most basic level, they just see things differently. Compound interest can illustrate that point.
Reframing Compound Interest
There is no arguing with the value and importance of compound interest. But, it is important to understand that there is nothing magical about that one year time frame. The world’s greatest investors don’t think in terms of years.
Great investors might think in terms of weeks or months and they compound wealth faster by continuously making new investments that generate profits they can reinvest.
Jim Rogers is an example of how to grow wealth fast. Rogers started investing with $600. Between 1970 and 1980 he partnered with George Soros and their hedge fund gained 4,200% while the Standard & Poor’s 500 only gained about 47%.
Rogers retired in 1980 at the age of 37 and has invested personally ever since. Some sources estimate his net worth at more than $300 million. He may be best known for taking motorcycle trips around the world.
Soros didn’t retire and is now worth over $25 billion but he wrote a book in the late 1980s that explained how Rogers and he ran their hedge fund. They looked at trades every day and wanted to hold positions for only a short time. Rogers and Soros were not trying to earn 10% a year. They were after 10% gains, or more, in a week.
By taking short-term gains, they achieved annual returns averaging more than 85% a year.
Could an individual trade like Jim Rogers and George Soros? Yes, they can.
Let’s say you had $1,000 to invest at the beginning of last year. You could have put it in an S&P 500 index fund and had $1,095 after the index gained 9.5% in 2016.
Or, you could have pursued a short term trading strategy averaging 1% a month. Let’s assume you traded every month until you made 1% and then stopped trading until the beginning of the next month. At the end of the year, your gains totaled 12%.
But, by compounding gains, your account value was up more than 12%. At the end of January, you had $1,010 which you traded to make 1% in February. By the end of the year, the account value would be 3% larger than an account that used a buy and hold strategy. Over five years, the difference in wealth is even larger with 15% more in the short term trading account.
Using Leverage Compounds Wealth Quickly
Now, let’s look at the kind of trades we highlight daily at our OptionsProfitDaily web site. We often highlight trades that require less than $200 of trading capital. These trades may generate a gain of $40 in less than two months. Let’s say you take two trades like this and find new opportunities as the existing positions expire.
This type of trading would generate gains of $80 every two months. Having two trades open might require $400 in trading capital. To be conservative we will assume that $1,000 in capital is committed to the trades. By the end of the year, $1,000 would have grown to $1,400, a 40% gain.
There are other strategies that we highlight that are shorter term and longer term. There are trades with significantly larger gains. There are trades with smaller gains but we tend to shy away from very low value trades although talking high probability trades yielding $10 in a week would be another way to grow wealth.
The key to wealth for many investors is compounding. However, if you compound wealth quickly, you don’t need to start investing 40 years ago in order to retire soon. You just need to look at the markets like Jim Rogers does and realize it could be best to make money quickly and often.
Options are an excellent way to pursue quick gains in the market. Many trading strategy are suitable for small investors and require just small amounts of trading capital. Many strategies allow you to take trades that last for a few days and many traders may find excellent opportunities in trades lasting less than two months.
Following these short term strategies with discipline could be the key to unlocking the “eighth wonder of the world” even if Einstein never really said that about compounding investment gains.