How Can Investors Earn Compounding Returns?
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Compound returns can turn even the smallest investment into riches…if you know how to invest it!
I don’t have enough left over after paying the bills to make investing worth it…it’s an excuse I’ve heard at least 30 or 40 times and it’s too bad because many of those people could be millionaires by now!
Even on as little as $50 invested each month, you can have hundreds of thousands saved for retirement and the power of compound returns means it takes less than you think to become a millionaire.
Let’s look at what compound returns are, the magic of this investing miracle and how to invest to make you rich!
What are Compounding Returns?
Call it compound returns or compound interest, the concept is the same. When most people talk about compound interest, they’re talking about their savings account. The interest paid by the bank on your savings adds up and earns interest every year.
It’s that little extra interest you make on the previous years’ interest that makes all the difference. It’s how Osceola McCarty was able to turn a lifetime of washing clothes, not exactly an occupation that would make her rich, into a $150,000 donation to the University of Mississippi in 1995.
She worked. She saved and she earned compound interest.
When we talk about compound returns on the other hand, we’re usually talking about investing…but again, it’s exactly the same idea. With compound returns in investing, you’re earning money on the money you’ve made. This usually comes from two sources,
- Dividends paid on your stocks can be reinvested to earn more money
- Money made on stock sales can be invested in other stocks
How Do Investors Earn Compound Returns?
Earning compound returns as an investor then means either investing in dividend stocks or selling some of your winners occasionally to realize those returns and then reinvest the money…or doing both.
Investing in dividend stocks is easy. We’ve got lots of articles on the blog about which dividend stocks to pick as well as putting your money in other income investments. When these investments spin out a cash dividend, you can reinvest the money back into the same stock or pick another one.
This is part of the reason why I love investing sites like M1 Finance or Webull that lets you buy fractional shares. You don’t have to wait until your dividend payouts are enough to buy a full share of stock.
The other way of earning those compound returns is a little more strategic because it involves selling some investments to buy others. The idea here is that you can’t earn a compound return on your investments until you reinvest that money, so earning a return then reinvesting it for a compounded return.
How to Invest for Compounding Returns
Deciding which investments to sell and how to reinvest to earn a compound return can be done through a couple of different strategies.
- One of my favorite compound return strategies is tax-loss harvesting every year. In November, I’ll look through my portfolio and add up all the unrealized losses and gains for each stock. Then I’ll sell a few of the winning stocks that I feel don’t have much further to increase and offset that gain by selling some of the losing stocks. I know it sucks to sell a stock at a loss but with this strategy, I won’t have to pay any capital gains taxes and I can reinvest all the returns to compound in a new stock.
- Every few years, or sometimes every year if the stock market has been on a run, I’ll go through and rebalance my portfolio. This means grouping all the stocks by sector and making sure I don’t have too much exposure in any one group. That can happen a lot when tech stocks are surging like they have been lately. When that happens, I’ll sell out of some of the weaker tech names to buy into more exposure in other sectors – and earn compound returns on the reinvested money.
- Another strategy is to focus more of your portfolio on income-earning investments. The more income you have coming into your account, the more you can reinvest and the more you can benefit from compound investments. My favorite income investments include: real estate, bonds, MLPs and dividend stocks.
Best Investments for Compound Returns
Building on that last strategy, some investments are better than others for earning compound returns. For example, a CD might be one of the safest investments you can make but it’s not going to grow your money very fast. On the other hand, rental real estate might give you another $500 or more a month to reinvest.
Here are the best ways for earning compound returns, in order from least to best.
- Certificates of Deposits – these and savings accounts barely keep up with inflation these days so aren’t going to give you much of anything to compound.
- Stocks might provide for a strong return over time but they don’t typically spin off much cash to reinvest. Compounding returns here means you’ll need to sell regularly.
- Bonds don’t earn much of a total return but the interest paid can be as high as five- or six-percent for some lower-rated bonds.
- Tax liens are some of the best passive income investments with most paying from 1% to 2% every month!
- REITs are like owning rental real estate but without all the management headaches. They spin off higher dividend yields than stocks, giving you more to reinvest.
- Rental real estate is the best compound return investment I’ve used and you can build a million-dollar portfolio by putting your rents to work buying more properties. It takes more work than the other investments but this is one every investor should check out.
Compound returns are truly the magic of investing and can make even the smallest amount a fortune given enough time. Whether you’re investing $50 or $500 a month, don’t pass up the opportunity to make money on your money!
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