The Power of Compounding

Making money entails more than merely predicting which way the stock or bond markets are heading, or trying to figure out which stock will double over the next few years. For a great majority of investors, making money requires a plan, self-discipline, and desire.

So in order for anyone to become successful as an investor, that person must have a plan.

One of the most important lessons we can learn about living in the modern world is that in order to survive, you've got to have money. But you'll never really know very much about money until you learn how to use and understand a set of the compounding interest tables.

Compounding is the royal road to riches. Compounding is the safe road, the sure road, and most importantly, anybody can do it. But in order to compound successfully, you need the following:

1. Perseverance - in order to keep you firmly on the savings path.

2. Intelligence - in order to understand what you are doing, and why.

3. Knowledge of the mathematics tables - in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road.

4. Time - in order to allow the power of compounding to work for you.

However, there are two ironies associated with the compounding process. The first should be very obvious - compounding may involve sacrifice because you can't spend it and still save it. And secondly, compounding can be very boring - that is until you have been at it for several years and the passive money begins to flow in. Then at that point, compounding becomes very interesting!

You can work your compounding with a good money market fund, T-bills, or even with 5-year Treasury notes.

Something else to bear in mind. If you want to become wealthy, then you must never lose big money. Unfortunately, most people lose money in disastrous investments, or by gambling, engaging in risky business deals, and sometimes simply through greed or poor timing.

In the investment world, a wealthy investor has one major advantage over a small investor, or a stock market amateur. The advantage that the wealthy investor enjoys is that he doesn't need the markets. The wealthy investor doesn't need the markets because he already has all the income he needs. He has money coming in via bonds, T-bills, stocks, money market funds, and even real estate.

A wealthy investor tends to be an expert on values. When stocks are a bargain, and stock yields are attractive, he buys stocks. When bonds are cheap and bond yields are irresistibly high, he buys bonds. And when real estate is a great value, he buys real estate. In short, the wealthy investor puts his money where the great values are. And if no outstanding values are available, the wealthy investor waits. And he can afford to wait because he has money coming in daily, weekly, and monthly. The wealthy investor knows what he is looking for, and he doesn't mind waiting months, or even years for his next great investment.

But what about the typical small investor? This person always feels pressured to "make money." And in return, he's always pressuring the market to "do something" for him. But unfortunately, the market isn't interested. So when the small investor isn't buying stocks offering 1% or 2% yields, he's off to Las Vegas trying to beat some casino at the blackjack tables. Or he's spending $20 a week on lottery tickets.

The typical small investor doesn't understand values, so he constantly overpays. He doesn't understand the power of compounding and he also doesn't understand money. He also never heard the truism: "He who understands interest - earns it. He who doesn't understand interest - pays it." Thus, this explains why the typical American is a person who is deeply in debt!

But here's the ironic part of it. If from the beginning, the average person had adopted a policy of never spending more than he earned; if he had taken his extra savings and compounded it in intelligent, income-producing securities, then in due time he too would have money coming in daily, weekly, and monthly, just like the wealthy person.

The only time the average investor should stray outside the basic compounding system is when a given market offers outstanding value. And we define an investment to be a great value whenever it offers: safety, an attractive return, and a good chance of appreciating in price. At all other times, the compounding route is safer, and probably a lot more profitable, generally in the long run.

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