Young Finance, the power of long-term compound returns

What is the right time to invest? Should you buy or sell a stock or a managed savings instrument right now? Answering questions like these is not easy, given that these decisions must respond to a unique and personal need of each of us: it is unthinkable that our neighbor or a friend of ours could have incomes, deadlines, commitments and coverage equal to ours.

The first rule of saving

But a basic indication can be given to those who wonder what to do with their money: the first rule is to define the amount of liquidity to keep in the current account for the management of periodic expenses, i.e. bills, mortgage payment, credit card and so on. Then we have to decide what to do with the excess part, that is the part that we manage not to spend and that it would be useless to keep in sight on the current account. This is the part we can invest: for a purchase within a year or two, for a future to be determined, for retirement.

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Time effect

Those who are younger have a huge advantage: time ahead of them, to have their money revalued over the years and have more when needed. When we stop working or when at a certain point we could decide, thanks to the nest egg set aside, to change direction and start a new business. The basic assumption is that in the long term stock market fluctuations lose relevance and the value of the main companies listed on international lists always rises: in the last ten years, the MSCI World index, which represents all listed shares, has revalued by 120%, with an average of 12% per year.

The composition of the yield

But to understand how the revaluation of our money works when it is invested, it is necessary to focus on the concept of compound return (different from simple return): when a rate is periodically applied to a capital, it produces an effect whereby after the first year the rate is it applies to capital + past returns, in a dynamic that sees, for example, the part deriving from the returns offered by financial markets increasing in proportion to the final result.

Over half thanks to the markets

Imagine having 100 euros and being able to set aside another 100 each year at a rate of 5% for 25 years. At the end of this period, more than half of what has been accumulated – 5,349.98 euros – will be the result of the returns or 2,749.98 euros and therefore only 2600 euros will be the money “saved” and subtracted from our consumption. The higher the rate of return obtained by investing, the more striking the final result. Ten thousand euros invested at the hypothetical rate of 10%, for example, becomes 11 thousand the following year; but after ten years they have already become 25,937, after 20 years 67,275, after 30 years 174,494 euros while after 40 years they have become 452,593 euros. Investing in the long term allows you to get a higher interest rate and therefore it is important to start saving money for retirement or for your long-term future as soon as possible.

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