Set It and Forget It: Harnessing the Power of Compound Interest Through Automatic Investing

Investing can be a daunting task for many people, but it doesn't have to be. One of the best ways to invest is through an automatic investment plan that takes advantage of compound interest. Compound interest is the interest earned not only on your initial investment but also on the interest earned over time. By reinvesting your returns, you can earn more interest, and your money can grow exponentially. In this article, we'll discuss how to invest and enjoy the benefits of compound interest in an automatic manner.

Understand the Power of Compound Interest

The first step in taking advantage of compound interest is to understand how it works. Compound interest allows you to earn interest on your principal investment, as well as on the interest that your money earns. This means that your investment will grow exponentially over time, as long as you keep reinvesting your returns.

For example, let's say you invest $1,000 in a fund that earns a 5% annual return. After the first year, you'll have earned $50 in interest. Instead of withdrawing that money, you reinvest it, so your new principal becomes $1,050. If you continue to earn a 5% return on that amount, you'll earn $52.50 in interest in the second year, bringing your total investment to $1,102.50. Over time, your investment will continue to grow, and your returns will compound.

Choose the Right Investment Vehicle

The second step in taking advantage of compound interest is to choose the right investment vehicle. One option is to invest in a mutual fund or exchange-traded fund (ETF) that has a history of strong performance. Look for a fund that has low fees, a good track record, and a diversified portfolio of stocks and bonds.

Another option is to invest in a high-yield savings account or certificate of deposit (CD). While these options may not offer the same potential for high returns as a stock or bond investment, they are generally less risky and offer guaranteed returns.

Set Up an Automatic Investment Plan

The third step in taking advantage of compound interest is to set up an automatic investment plan. This is a plan that automatically invests a set amount of money from your bank account into your chosen investment vehicle on a regular basis. You can choose to have the money transferred weekly, bi-weekly, monthly, or quarterly.

Setting up an automatic investment plan ensures that you consistently invest money, and it takes the emotion out of investing. You don't have to worry about market fluctuations or timing the market. By investing regularly, you'll benefit from dollar-cost averaging, which means that you'll buy more shares when the price is low and fewer shares when the price is high.

Reinvest Your Returns

The final step in taking advantage of compound interest is to reinvest your returns. As we mentioned earlier, compound interest means that your returns will earn interest over time, so it's important to reinvest them back into your investment vehicle. By doing so, you'll increase your principal investment, which will lead to even higher returns.

There are multiple options for setting the automatic reinvestment of your returns:

• DRIP (Dividend Reinvestment Plan): Automatic reinvestment of dividends to purchase additional shares or fractions of shares.

• AIP (Automatic Investment Plan): Regular automatic investment and reinvestment of dividends or capital gains.

• Robo-advisors: Automated investment platforms that offer automatic dividend reinvestment.

• Brokerage account settings: Automatic dividend reinvestment or the purchase of additional shares can be set up in your brokerage account preferences.

Another example of the power of compound interest:

Let's say that in 1970, an individual invested $10,000 in the S&P 500 Index, which is a stock market index that measures the performance of 500 large companies listed on stock exchanges in the United States. At the time, the S&P 500 Index had an average annual return of around 5.9%.

Assuming that the individual reinvested all dividends and capital gains back into the investment and did not withdraw any money, here's how the investment would have grown over time:

• In 1970, the initial investment of $10,000 would have grown to $10,590 (including the 5.9% return).

• By 1980, the investment would have grown to $26,532.

• By 1990, the investment would have grown to $65,506.

• By 2000, the investment would have grown to $223,020.

• By 2010, the investment would have grown to $482,596.

• And as of the end of 2021, the investment would have grown to approximately $1,032,562.

As you can see, the power of compound interest over a long period of time can result in substantial growth in the value of an investment. The compounding effect of earning interest on interest over multiple decades can lead to exponential growth. Therefore, it's important to start investing early and stay invested for the long term, as it can help you take advantage of the benefits of compound interest.

In conclusion, investing and enjoying the benefits of compound interest is a great way to grow your wealth over time. By understanding how compound interest works, choosing the right investment vehicle, setting up an automatic investment plan, and reinvesting your returns, you can take advantage of the power of compounding and achieve your financial goals.

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