Compound interest

I would follow the stock market secret of compound interest to get rich and retire earlier

Many billionaires around the world can credit their fortunes with a lifetime of buying and holding investments. They usually do this by buying an undervalued stock and resisting the urge to sell, even when financial markets are in turmoil. This can be a difficult concept for new investors to grasp, but the reason is simple: Compound interest works wonders.

What is compound interest?

Capitalization is the power to earn interest on your investment, and as that investment increases, the amount paid (earning interest on interest) also increases the starting pot exponentially. This is much more powerful than it first appears, although a buy and hold strategy may not seem profitable at first. But I think its beauty lies in its simplicity and its perceived ability to achieve the impossible.

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For example, if you take 1p and multiply its value every day for a month, by day 30, you will have over £ 5.3million.

This is a crude example of the power of exponential composition, but it illustrates how the acceleration of wealth occurs towards the end of a long period. Following this premise, stocks that pay dividends, which are reinvested to accumulate more stocks, follow a similar trajectory.

This explains why dividends have always been the lifeblood of a value investor’s portfolio. Unfortunately, the pandemic has thrown a wrench into the works, resulting in 445 London-listed companies canceling, cutting or suspending their dividend payments in recent months.

Is value investing a smart strategy?

As there is no sign of a rapid recovery in the Covid-19 situation, many of these dividends are unlikely to be restored soon. So is value investing still a smart strategy to follow in these times?

I think so. Financial markets have always had their ups and downs, but the general trend is upward. Of course, past performance is not a definitive guide to future performance, but as long as there is a stock market, I believe there will be listed companies that will benefit from long-term growth and expansion. term. With that in mind, now is a great time to buy stocks that are currently undervalued and likely to recover over time. Some companies with a reduced dividend still offer a decent return. If it looks like a business can weather headwinds and eventually recover, this could be the perfect time to buy.

Define and forget

Focusing on the big picture and ignoring the short-term landscape is key to building long-term wealth. If you invest a lump sum with dividend reinvestment enabled, it will eventually add up. For example, if you invest £ 1,000 without adding any additional capital, but reinvest the dividends at a rate of 5%, your final sum after 40 years will be over £ 7,000.

If you do the same, but also invest an additional £ 100 per month, your final total will be over £ 155,000.

If you increase the interest rate to 11%, the above scenarios will increase the final total to over £ 65,000 and £ 804,000, respectively. The more you can afford to invest and the higher the interest rate, the better your investment will perform. If you want to get rich and retire early, I think you should follow in the footsteps of stock billionaires. Follow a value-driven investing strategy that takes full advantage of the power of compound interest.

The opinions expressed on the companies mentioned in this article are those of the author and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. At The Motley Fool, we believe that considering a wide range of ideas makes us better investors.

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