The Compound Effect


In last week’s article I discussed how by making just 3% can amount to a potential large return and how by focusing on the percentage return rather than the actual monetary value of a trade can benefit you. As by trading with this approach can allow you to be consistent with a small account but will also allow you to be consistent when at one point you begin to manage bigger amounts of trading capital.

This week I am still going to be sticking with a similar theme in terms of money management but this week I am going to be expanding how by compounding your trading gains can realise exponential returns over time.

So, what is the compound effect? Some people believe it to be the 8th wonder in the world because of how effective and powerful it is. The reason it is so effective is because you are essential leaving all or a big portion of your returns in your trading account instead of withdrawing on your profits, to then grow your account at a much faster rate.

A lot of traders get stuck in never being able to grow their accounts effectively and the main reason is because they always withdraw their trading profits. So, if you are constantly withdrawing your profits and never adding money into the account, how can it grow?

Now of course you want to withdraw some of your trading profits because you have worked hard to earn the money but the more you withdraw the longer it will take to grow your account and the faster we can grow your account the bigger your potential returns. Because remember if we trade with a £10,000 trading account and make an annual return of 36% then our ROI is £3,600. But if we trade with £100,000 and make the same return of 36% our ROI is now £36,000! So, the aim is to grow our account as by making the same returns but changing how much capital we trade with dictates how much we make.

A good rule of thumb is hold back and re-invest 20% of your trading profits every year. However, in my opinion if you can try and re-invest 50% of your annual profits back into your account. Why 50%? Simple, because it will take you less than half the time to get to where you would be if you was only re-investing 20% and through compounding 50% of your gains each year the quicker the compound effect will be.

What you need to remember and where a lot of people actually forget is that trading (speculation) is an investment vehicle, now of course your money is your money and you are free to do what you want with it but the goal should be to always make more money.

So if you start with a £10K trading account and each year with draw the profits and never re-invest then in 10 years you will still only have a £10K account and still only making an average profit of £3,600. However, if you start with a £10K account and re-invest 50% each year of your returns back into the account then in 10 year’s time your trading account will be… £52,338. That is what your account balance will be by compounding your gains each year of an 18% return as you will be withdrawing 50% of your trading profits.

But lets say you don’t withdraw from your trading account over the 10 year period.

Still sticking with the same example of your principle starting balance of £10,000 and making an average return ROI of 36% through compounding your profits in 10 years time your trading account will be… £216,465.

That is with a trading account of £10K so if we go with a different example and lets say our principle balance is £50,000 then in 10 years time along with using the compound effect with an average ROI of 36% annually.

By year 10 the account is worth 1,082,328.

So in just 10 years by taking £50,000 and constantly re-investing it back into the markets we have cleared £1Million in profit by making the exact same returns but through compounding the gains each year in the account we have seen exponential growth in the account.

This is why in my opinion trading Forex through speculation is the fastest way to accelerate your wealth because there is no other investment vehicle where you can manage your own money and turn £50K into £1Million in 10 years.

This is the power of the compound effect in trading as again we start with a principle balance of £50,000 and every year we look to make an average return of 36% ROI and through us doing our job correctly by doing the exact same thing each year we can see exponential growth.

Now the more you can start trading with first i.e. the larger the principle balance the faster you will see bigger returns as you are clearing what nearly took you 10 years of trading with a £10k account in 2 years if you started with £100,000 trading account.

So the more money you have the faster you will see the compound effect work but this is where you really need to be thinking long term with your trading and the potential you really have rather than short-term and thinking £3,600 isn’t a lot of money in your first year.

Now let’s say you are 25 and have £10,000 to invest into your trading account and you can compound 100% of your trading profits each year with an average return of 36% ROI. By the time you are then 45 your trading could be worth £4,685,739.

So before your not even 50 years of age you have got nearly £5,000,000 in your trading account but lets say you still continue to compound your account for 5 more years.

In 25 years through compounding £10K with a 36% ROI each year meaning your initial investment is only still £10,000 as you aren’t adding extra funds outside if trading only the profits you make through actually trading the markets by year 25 the account would then be worth £21,800,813! So by the time you are 50 years of age you have made nearly £22 Million in profit from an initial investment of only £10,000!

This is why you need to be thinking of trading not in the mind set of what you can make in year one but what you can make in 10+ years and beyond as through compounding the gains you will see exponential growth unlike any other investment vehicle and still have the ability to completely manage the fund by yourself.

So this is what 3% per month can really make you if you are able to compound 100% of the gains each year and all you need is an initial investment of £10,000 to make £22 Million in 25 years.

Now in comparison to buying a property as people always believe the best investment is property to buy an average property in the UK as of 2020 you will need a 10% maybe 15% cash deposit and houses prices outside of London average between £200K-£300K.

If we then go with an average of £250K you will then need at minimum £25K cash deposit to purchase the house with a 90% mortgage.

That £25,000 invested into the property over 25 years based on historic data which shows on average house prices increase by 3% would then show a profit of £27,344.

So, in 25 years you have only just doubled your money if you was to invest £25K into a property in the UK right now. That isn’t to say we won’t see prices depreciate or any future economic uncertainty affect the returns. Unlike trading where you know your trade plan works in any economic climate, so your annual returns are much more consistent.

Whereas through speculation with an average return of 36% that deposit for a house could be worth £54,502.034 in the same 25-year period.

This again proves how speculation is the fastest way to accelerate your wealth and the power of compound interest has when used correctly.

So in my opinion property is terrible investment mainly because you have an interest rate on the mortgage and typically when you have paid the mortgage off you paid for the house twice as more and more people are taking longer-term mortgages to make the monthly payments more affordable as the total balance is spread over a longer period of time.

1. Purchasing the house once the mortgage balance is clear by the end of the mortgage contract period.

2. Paying the value of the house again through annual interest to own the mortgage.

To finish this article off this is why compound interest is so effective as it allows you to see exponential growth even when using a small investment because through compounding the returns you see a dramatic ROI. Also, this again is why you need to be thinking long-term and not short-term when it comes to trading because what is possible in year 1 is dramatically different to year 10.


I hope you enjoyed this read and it was able to see you the longer term capabilities and possibilities within trading,


I hope you have a good week!


H.

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