Investing isn’t exactly known for delivering instant gratification. In fact, the big benefit of investing – building wealth in a portfolio – occurs steadily over years and even decades. While shorter-term investment trading does have its role in portfolios, it is through investing over longer periods of time that your hard-earned savings can grow into real wealth.
However, to be able to build wealth successfully, investors must have the discipline to keep contributing to their portfolios on a regular basis (even in volatile markets). Below, we describe the two main benefits of investing regularly – dollar cost averaging and compound returns – and how investors can easily automate the process with our Auto Invest feature.
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Dollar Cost Averaging
Dollar cost averaging is an approach that allows investors to take advantage of attractive market prices over time without having to worry about the timing of their trades (buys and sells). Trying to “time the markets” – i.e. to try to pinpoint the exact low point to buy or the high point to sell – is not only difficult but may well be impossible. In many cases, investors miss opportunities by waiting too long. I think we can all think of a time when we’ve done this in real life, such as with real estate or an online auction!
With dollar cost averaging, rather than trying to time the markets and invest at an exact price, you can instead invest in regular increments over a period of time. This helps smooth out the price you pay for your investments over time by averaging out the highs and the lows paid. This works especially well when you are uncertain about the direction of a stock, fund, or the overall market.
For instance, an investor who wants to invest $1,000 in an ETF might do so over the course of ten months rather than all at once to benefit from dollar cost averaging. They would invest $100 each month, regardless of the ETF’s price at each time. If the ETF price happens to be low, they take advantage of the cheaper price. If it happens to be high, they can benefit if the ETF price goes higher, but they also won’t be investing the full $1,000 at that one (high) price.
Investing regularly also allows an investor who wants to save and invest a certain amount in their portfolio each year to get started and invest in smaller increments the course of the year, rather than wait until they have all of the funds available at once. By investing regularly across a portfolio of multiple securities (such as multiple ETFs for MoneyLion investors), investors can build a portfolio while not having to think about every move in the stock market or, worse, risk overreacting to market fluctuations and jump in or out of investments at the wrong time.
The Power of Compounding
Another reason to keep investing consistently over time? Glorious, glorious compound interest.
When you can invest over a long time horizon (aka, invest over a longer period before needing to withdraw), this allows the value of your investments to “compound,” magnifying the growth of a portfolio. Albert Einstein famously called the power of compounding the “eighth wonder of the world.”
At its core, compound interest is simply the idea that your investments can grow exponentially over time. Not only does your initial investment generate returns, but your past gains also generate returns. Over time, this can have a snowball effect in creating wealth, making it a powerful tool for savers and investors.
As a simple example, imagine that you begin with $1,000 in an investment that returns 10% per year. After the first year, your investment will have grown 10% and be worth $1,100. In the second year, not only will your initial $1,000 investment return 10%, but last year’s gain of $100 will also grow by 10%. By itself, the initial $1,000 would have generated $100 each year, for a total of $1200. However, because your past gains also benefited, your portfolio is actually worth $1210. While that extra $10 may seem small, this process continues and eventually can add up to a large amount over time.
Compound Interest: The Rule of 72
The key to taking advantage of compounding is to contribute often and stay invested. One simple math trick that investors often use is known as the “rule of 72.” This rule tells us how long it takes for your investment to double based on the power of compound interest. For instance, if I expect my investments to generate a compound return of 10% per year until I retire, then my portfolio will double in value about every 7.2 years (72 divided by 10). This is a handy way to understand the impact that compounding has over saving alone.
Rule of 72: It’s a simple rule of thumb for understanding how long it takes an investment to double based on a compound rate of return. Alternatively, it can tell you what rate of return you need to double your investment in a certain amount of time.
Auto Investing Makes Growing your Investments Easier
Automating the process of investing on a regular basis can help you to take advantage of the benefits above: potentially more consistent returns over time, less stress over market fluctuations, and growth from compound interest. Arguably, the biggest hurdle in investing is our own behavior. We have a natural tendency to procrastinate and overreact to market movements, which can do significant harm to portfolios. Additionally, adding funds frequently and consistently is the best way to build your account over time. However, by automating the process of investing, such as with MoneyLion’s Auto Invest, you can stay disciplined over long periods of time.
For instance, you could set up an automatic investment into your existing portfolio on a weekly or monthly basis, possibly with each new paycheck. These investments could be spread across your existing funds in order to match your current goals and objectives. Doing this is consistent with the dollar cost averaging approach discussed above and will generate compound returns over time.
Perhaps the biggest benefit of setting these investments on autopilot, however, is that the investor doesn’t need to think about the portfolio constantly. This provides for peace of mind, all while doing the right thing from a wealth-building perspective.
When you invest with us, we’ll help you set up an automatic investment plan that works for you and invest it in a personalized, managed portfolio for you. It’s simply a smart, easy way to invest! And you can start with as little as $1.