A compounding strategy is a technique that protects you against inflation. Without complicated analysis, you invest in assets that have a high return.

Inflation is like a wolf that constantly lurks to ambush all your investments. Profits that have been accumulated for years can disappear in an instant if hit by inflation. But don't worry; you can overcome inflation by learning the compounding strategy. This is a secret technique that will make you immune to inflation.

compounding strategy

 

Understanding the Compounding Strategy

The compounding strategy is like a snowball rolling down a hill. The farther it rolls, the bigger it gets, and the faster it moves. The compounding strategy can help you overcome inflation with this snowball principle.

The compounding strategy is also often known as compound interest. If you reinvest the returns into your capital, your capital will continue to grow yearly. The additional growth will also accelerate, following the previous earnings as a reference.

This compounding effect has helped Warren Buffet become one of the wealthiest investors in the world. Some sources say 99 percent of Buffet's wealth was achieved after his 50th birthday. If he stopped investing at age 50 and withdrew all his money, Buffet would only have 1 percent of his current wealth. That is the power of the compounding strategy for long-term investments.

 

How Does Compounding Strategy Work?

In 2022, inflation in the UK rose due to the ongoing energy crisis and supply issues, leading to its highest level in recent years. The average inflation rate in the UK between 1989 and 2021 was 2.5 percent and is projected to reach 7 percent by mid-2022.

To combat inflation, investors must seek consistent investment returns of at least 3 percent. However, expecting long-term returns of 5-8 percent for equity investors is unrealistic. The S&P 500 had an average return of approximately 10.5 percent annually from 1957 to 2021. Long-term investors can still retire earlier and overcome inflation.

Let's examine the case studies of two investors who implemented the compounding strategy. One started investing young, while the other started later in life.

  Jack John
Starting time 20 years old 40 years old
Amount of investment $500 per month for 40 years. $1,000 per month for 20 years.
Total investment $240,000 $240,000
Their investment amount at age 60 (assuming it's a 7 percent return) $1,005,751.39 $393,895.50

The case studies show the incredible power of compounding. This strategy can overturn assumptions and skyrocket the wealth of an ordinary trader or investor. Compounding can exceed expectations because investing at a young age can achieve more than you expect.

The above case studies show that Jack's amount is almost three times John's investment amount. However, both invested the same amount. The snowball effect of compounding gave Jack more time in the market than John's portfolio, as he has been in the market for 40 years.

 

3 Compounding Tips

If you want to use a compounding strategy to overcome inflation, you must invest for as long as possible and target a high rate of return. Here are three compounding tips that you can apply to multiply your returns.

 

1. Start Investing Early to Overcome Inflation

The earlier you start investing, the greater the impact of compounding on your portfolio. It's like rolling a snowball to the top of Mount Everest. The further the ball rolls down, the fatter it gets.

If you invest $10,000 and achieve a 7 percent return, its value will be $38,697.12 after 20 years, $76,123.43 after 30 years, $149,744.67 after 40 years, and $294,570.85 after 50 years.

 

2. Aim for High Returns to Overcome Inflation

Aiming for high returns will help you overcome inflation to the maximum extent. To achieve high returns, you have to look for a combination of capital growth and dividend income.

If you want high capital growth, consider investing in small companies. Historically, small companies perform better in investment growth than larger blue-chip stocks. The FTSE Small Cap Index has risen by 27.3 percent in the past five years to March last year. Meanwhile, the FTSE 100 has barely budged and only increased by 1.84 percent.

Many blue-chip companies offer a minimum dividend yield of 4 percent for investors seeking dividend income. For example, shares in global mining company Rio Tinto have grown by 93.3 percent in the past five years to March 2022 and offer a dividend yield of 10.1 percent. On the other hand, although shares in the UK building company Persimmon have only grown by a minimal 1.2 percent in the past five years to March 2022, they offer a high dividend yield of 10.6 percent.

 

3. Stay Focused on Investment Plans

To stay focused on your investment plan, especially during volatile markets, it is essential to avoid emotional triggers and consistently follow your long-term plan by investing regularly. Sometimes, when the market is slow, continuing to invest can result in profits when stock prices rise again.

Implementing a long-term investment plan means investing regularly regardless of market conditions. This way, you can buy stocks when they are too cheap, too expensive, or in any condition.

In fact, by continuing to invest when the stock market is falling, you can make profits in the future. For example, in March 2009, the S&P 500 dropped to $683.38 from its previous peak of $1,525.75 in September 2008. However, as of March 2022, the S&P 500 has reached $4,495.55. If you invested £10,000, your investment would now be worth around £65,812.

 

Conclusion

Although investing always carries risks, the investment compounding strategy can help overcome inflation while achieving your financial goals. Strategies such as choosing high-dividend stocks, investing long-term, and seeking high capital growth can help you win the investment battle and retire early.

 

Compounding is a great way to initial capital from the profits earned in trading. What is the best method for compounding profit in forex trading?