If you were to attend one of those lectures by financial gurus, one of the hot topics being discussed is likely to be about savings.
Now, for serious investors, they always set aside a portion of their earnings so that they can save for their retirement.
Rather than letting your savings lie idly in some bank account, you can make it work for you. What we mean is that you can use the money for other investments.
In your search for the ideal investment, you must have come across the term compounding returns. On top of that, you may also have heard of the opportunity that these returns present to you.
If you want to take advantage of compounding returns, but you have no idea where to start, you have come to the right place. In this article, we are going to try and tell you all there is about compounding returns.
What are Compound Returns?
This is whereby the growth of your investment’s value is not only based on the original principal but is also based on the returns that have been generated by the investment.
Let us use a simple example to boost your understanding. Supposing you put $1000 into an investment that has an annual compound interest rate of 10%. At the end of the first year, you should be having $1100 i.e., the initial amount plus the 10% return on the original investment.
At the end of the second year, this amount should have grown to around $1210, and it should have reached $1464 by the end of the fourth year.
How to Get Compounding Returns from Investments
First, before an investment qualifies for compounding returns, there are two requirements that it has to satisfy:
(i) It should pay returns to the asset holder in the form of an income stream such as interest and dividends
(ii) Then, the investor should reinvest those returns in the base principal, and this is what would be used to calculate your profits
Meanwhile, the investment product that satisfies the above requirements can offer compounding returns in two main ways:
This is a fixed rate of return that is calculated on the underlying principle. In case there are any gains, they would be added to this principle so that the rate of return could also increase.
In this instance, the investment comprises of several assets compiled together, including a stock portfolio. If any of these holdings generate any income, the asset would automatically have an increase in value.
These gains would then be used to acquire more assets, and so the investor would have more income-generating holdings.
How Can Investors Receive Compounding Returns? The Right Products
If you want to receive compounding returns, you need to invest in the right products. Luckily for you, numerous investment products offer compounding returns.
We are going to analyze some of the most common products in detail.
I) Mutual Funds
Just a reminder, mutual funds operate by pooling cash for investing in stocks and other assets, and they are a sure bet for compounding your returns.
Another thing to note is that instead of paying dividends to the investors, mutual funds reinvest the funds into acquiring more shares. As the fund purchases more shares, it continues to earn more compounding interest.
A significant advantage of mutual funds is that their tax rate is lower relative to the individual rate. This is one of the reasons that mutual funds are so appealing.
II) Certificate of Deposit (CDs)
This is a savings product that is offered by most banks and other financial institutions such as credit unions. It has a predetermined maturity date, while the interest is also fixed.
Most of all, CDs are entirely risk-free due to the FDIC coverage of up to $250,000 per person.
So, if you have any funds lying idly by, invest in CDs and let your money work for you.
III) Exchange-Traded Funds (ETFs)
ETFs are similar to mutual funds in that they invest in dividend-paying stocks. Some of the ETFs offer dividend distribution reinvestment plans (DRIPS), which allow you to exchange your dividends for shares in the ETF.
In the process, your returns will be compounded over time, and your profits would be growing too.
IV) Zero-Coupon Bonds
These bonds are structured differently from traditional bonds, and they do not have an interim cash flow.
While they pay compound interest, zero-coupon bonds are also characterized by fixed interest rates as well as the schedule and repayment date.
Upon maturity, the bond will be worth a discounted rate of its face value.
If you want to make steady and high returns with as minimal research as possible, crowdlending is the way to go.
Most platforms that offer this service have an auto-invest feature. As soon as it hits the ground running, the platform will be automatically investing in loans for you every day.
VI) Shares and Index Funds
Here, instead of treating your annual dividends as income, you could opt to use them for acquiring more shares in that particular stock.
If that stock is paying a dividend while the share price is steadily growing, you could benefit a lot from compounding returns.
You could do the investment manually or employ the services of a broker to save time.
VII) Rental Income
While this may not be as direct as the other products that we have mentioned, the principle behind it is the same.
You can reinvest your rental income in acquiring more property and in renovations too. This way, you would have more tenants, and this translates to more rental income.
One Thing To Keep In Mind
When looking for viable investment opportunities, you are going to come across a lot of scammers promising you quick money with little risk.
Well, the thing is that there is no investment scheme that does not carry a risk. It is up to you to do proper research on the scheme, settle on the appropriate strategy, and then learn to manage your risk portfolio appropriately.
So, if you’re wondering “How can investors receive compounding returns?” We hope you’ve found this read worth your while.
To sum it up, compounding investments may harbor its fair share of challenges, but once you get it right, it can be a sure way to grow your wealth.
Before you invest in a particular product, ensure that you conduct sufficient research on it so that you can minimize your risk of loss.
Most of all, be patient and do not expect your riches to grow overnight.