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The Power of Compounding (How to build wealth)

Written By David D'Angelo on Monday, January 14, 2008 | 1/14/2008

One of the things you need to know about building wealth is the power of making regular periodic investments and reinvesting rather than spending the profits.

The results you will with this discipline are surprising. Let’s say you start with nothing, and decide putting PhP 5000 of your income into an investment account every month, and you commit not to touch your money in investment. That means you can’t take withdraw any funds until you’ve reached your long-term goal.

The overall market, at least as measured by the S&P 500 index, returned 11.8%, on average, annually over the past 10 years. If you achieve that same return, you’d have PhP 1,140,000 after 10 years. But it gets better. You’ll have PhP 4,860,000 if you stick with the plan for 20 years and a cool PhP 17 million in 30 years.

The process described here is a combination of two powerful investing strategies: compounding and peso-cost averaging.

Compounding is simply reinvesting rather than spending your profits. By doing that; you capture the future returns on your reinvested profits as well as on your original investments.

Peso-cost averaging means that your fixed monthly investment buys more shares of a mutual fund or stock when prices are low, and fewer shares when prices are high. For instance, if you were investing PhP 5000, you’d get 500 shares if a stock were trading at PhP 10, but roughly 555 shares if it dropped to PhP 9.

Discipline Required. The hardest part of implementing these strategies is making the regular monthly investments. It’s easy to procrastinate adding to your account if the market is down or if you could use the cash for something else.

The best way to make sure that the regular investments happen is to automatically deduct a fixed amount from your monthly salary and directly invest it in a mutual fund account every month. (Reference: www.colaycofoundation.com)

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