As an investor, you're looking to make money from the stocks you own. The tools that do most of the heavy lifting on your behalf are growth and compounding. Over time, they can work together to build the wealth you anticipate from investing.
That's what makes the stock market chart you see below such a powerful tool in your investing journey. It can make you a smarter investor by showing you how those two tools, with a little bit of patience sprinkled in for good measure, can turn your cash into a tremendous nest egg over time.
Data source: Yahoo! Finance. Chart by author.
What that chart is telling you
The SPDR S&P 500 ETF (SPY -0.38%) -- also known as the S&P Depository Receipts -- launched in January of 1993. It provides investors a low-cost way of investing in an exchange-traded fund that tracks the S&P 500 index. That index contains 500 of the largest U.S.-based companies and is frequently used as a proxy for the overall market.
That chart shows how far a single $100 investment in that ETF would have grown between its launch and Dec. 4, 2020. The blue line shows the growth in the price of the index itself, while the green line also includes the compounding benefit from reinvesting dividends. Based on growth alone, that $100 would have turned into $841.76, and with compounding, it would have reached $1,418.16.
In other words, just a few decades later, a single investment could have been worth over 14 times as much as it originally was, just through the effects of growth, compounding, and time. That is the key to building wealth in the stock market, and that is what makes it accessible to nearly anyone with a bit of cash and the time and patience to let the market work its magic.
It's not a straight line up
The other key thing you can learn from that chart is that while the market has helped generate incredible wealth for people over time, returns have not gone straight up. There are a handful of noticeable dips in that chart. In particular you can see the dip from the dot-com implosion around the year 2000, the one from the financial meltdown around 2008, and more recently, the 2020 dip from the coronavirus pandemic.
Image source: Getty Images.
What that should tell you is that, despite their long-term potential, you can't count on stocks in the near term. As a result, money you need to spend in the next five or so years does not belong in stocks. Instead, for money you know or can reasonably expect you will spend, consider cash, CDs, money market funds, or duration-matched Treasury or investment-grade bonds.
Especially in today's low interest-rate environment, you won't earn much on the money you have set aside for near term needs. What you are doing, however, is vastly improving the odds that when you need the money, it will be there for you. A five-year buffer means that the next time the market crashes, you won't immediately need to sell your stocks that have dropped in order to cover your costs. It also gives you time to wait for the market to recover and to adapt if that recovery is slow to materialize.
Compound more of your money
Importantly, remember that that chart showed the value of a single $100 investment, compounded over a few decades. If, instead of just a single investment, you invest regularly, you can turn a little bit of regular cash into a tremendous nest egg for yourself and your family. The table below shows how much a regular monthly investment can turn into after 30 years, depending on the amount you invest and the rate of return you receive over time.
|
Monthly Investment |
10% Annual Returns |
8% Annual Returns |
6% Annual Returns |
4% Annual Returns |
|---|---|---|---|---|
|
$1,000 |
$2,260,488 |
$1,490,359 |
$1,004,515 |
$694,049 |
|
$500 |
$1,130,244 |
$745,180 |
$502,258 |
$347,025 |
|
$250 |
$565,122 |
$372,590 |
$251,129 |
$173,512 |
|
$100 |
$226,049 |
$149,036 |
$100,452 |
$69,405 |
Calculations by author.
As you can see, making the commitment to investing regularly can potentially result in you accumulating a life-changing amount of money over time. While past performance is no guarantee of future returns, the market has delivered returns near that 10% annualized rate over the long run. That makes it feasible for you to reach millionaire status within your career, even by investing relatively modest amounts of money every paycheck.
The key to making that work, however, is to get started soon. The earlier you get started, the longer you give the market's twin tools of growth and compounding to work on your behalf. So get yourself in a position where you can invest, and then make it a habit with each payday. Once you've put in enough time to see the benefits of growth and compounding working on your behalf, you'll be very glad you did.
