Compounding an Investment is the key to earning a high return. Compounding can also generate a lot of passive portfolio income.
And sure, we’re taught about the value of compounding investments at a young age. But nobody really talks about the different ways you can actively apply compounding to improve your investing returns.
In this short blog post we’ll look at how you can compound an investment. I’ll also share with you some ideas I have on how to compound your investments more actively so you can improve the returns you’re seeing from your stock portfolio.
Compounding an Investment – The Basics:
Compounding an investment is pretty simple math. When you have an investment, you expect to earn a percentage on your invested capital. So as an example, if you invest $10,000 and get a 10% return, your capital gain would be $1,000. Simple, right? Now, compounding comes into effect when you let the $1,000 of investment income continue to earn income for you. Any percentage return you earn next year on the interest from last year, is compound interest. Does that make sense?
If you want to experiment a little more with the basics of compounding, I suggest you check out this compound interest calculator. It’s really robust and let’s you experiment with the different way you can grow your savings. A little experimentation here can really illustrate the value of compounding your investment.
But if you’re already familiar with the basics of compounding and looking for more active ways to pursue passive portfolio growth, then keep reading…
Compounding an Investment – Active Compounding Tactics:
While every financial planner under the sun can preach the value of compounding your investments, they never talk about how to actively compound. Common wisdom says you should just keep buying stocks, re-invest dividends and re-balance your portfolio once or twice a year. I’m sure you’ve heard that before. But let me ask you…
What if there was a better way to compound your investments? What if you could actively compound your investments every quarter, month or week? Would that be interesting to you?
The Best Trading System Book was the first investment book I discovered that really put the power of active compounding front and centre. That investing book is quite simple but focuses exclusively on the idea of actively compounding your investments and how this can super-charge your portfolio returns. I also talk about it in my free mini-ebook (accessible on the side of this site). Here’s how it works…
First of all, even active compounding takes time for you to reap big investment rewards. So active compounding is still predicated on owning great companies at fair prices (which is what most fundamental buy and hold investors should aspire to anyways). But the key difference in active compounding is that you don’t just forget about the investments in your portfolio and keep reinvesting the dividends (as traditional compounding wisdom dictates).
Instead, active compounding requires that you watch the price chart of your fundamental investments. Even if you’re not a technical analyst you can still use short-term market inefficiencies and exaggerated price movements to manage the size of your investment position and take advantage of compounding opportunities. For example, if your stock jumps up 5% on low volume and no news items, you may want to sell 1/3 or 1/4 of your position. Then, when the stock pulls back 2-3% you can re-buy it. Obviously this takes some practice and you’re not going to get it perfect every time. But that’s okay. Just remember…
Since you are only focusing on stocks you like long term for fundamental reasons, you don’t have to be perfect. You can hold your positions if they go against you the same way a long term investor would. But when you re-buy companies at lower prices you actively compound your gains.
And I guess if stock picking isn’t your thing you could even practice active compounding of your investments using ETFs like the SPY. You would have to maintain a long bias, where something like 50% of your portfolio would always be invested as a long term buy and hold investor, but then you could also use the other 50% of your portfolio to compound actively. Does that make sense?
Active compounding of your investments doesn’t have to be rocket science. If you just look a little harder than most to apply the magic of compound investing you can really improve your stock portfolio performance. Sound good?
And By the Way: If you’re looking for more information on how to compound your investments, then sign up using the form below. I’ll send you a free copy of my mini-ebook “The Intelligent Swing Trader” which explains in much more detail how I actively try to compound my investments. So check it out! What do you have to lose?