We’ve all heard of the ridiculous notion that giving up your daily cup of coffee and avocado toast will help you get a downpayment on a home – but there could be some method in the madness.
While investing is obviously not at the top of people’s minds at the moment (cost-of-living crisis anyone?) but even small contributions to an investment portfolio every month could seriously add up, thanks to compound interest, according to new data from Sharesies.
What does this have to do with coffee?
Assuming your usual coffee is $5 and you hold back from buying one to three of these every week – so around four to 12 coffees worth of cash every month – you could potentially earn up to $9,833 over 10 years.
Assuming the average rate of return was 6 per cent, you would save $7,200 and earn $2,633 in compound interest over a 10-year period.
Here’s a breakdown:
What is compound interest, and how does it work?
Sharesies Australia country manager Brendan Doggett said you should think about compound returns like a plant.
“If you plant a seed, down the line you’ll have a little plant. This plant will then drop more seeds and, if it grows well, soon you’ll have two plants,” Doggett said.
“These will then drop more seeds, hopefully, create more plants, create more seeds, and so on, until you have a whole meadow. Now, even if you chop down that very first plant, you’ll still have lots of plants left working hard to create new plants.”
Essentially, compound returns work in the same way. You make an initial investment that then generates returns. By reinvesting those returns, not only would you be earning money from your initial investment, but also from those additional returns.
“Just as with your little plant, this will keep going until you see returns on your returns on your returns, and so on,” Doggett said.
“This process can happen in two key ways: if your investment goes up in value, or if you reinvest your dividends. While the specifics of how this works vary, the principle is the same – reinvesting your returns means that the money you’ve made has the potential to make you more.
But doesn’t the share market go up and down?
Yes, and there is always a risk with investing.
“In real life, share prices and dividends are likely to go both up and down in value and so it’s not always a linear journey, but it can provide a great opportunity,” Doggett said.
Some investors use dollar-cost averaging, which is when you set an amount to invest on a regular basis, regardless of the share price.
“So, when the share price is higher, you’ll purchase fewer shares and, when it’s lower, you’ll purchase more. The strategy aims to average out your cost per share over time, rather than timing your buys with specific high or low points in the market,” Doggett said.
“This tactic can make your compound returns even more powerful because you’re giving your money more opportunity to earn returns over time. If you keep adding to your investments, even if it’s a small amount, then you have a greater chance to make returns and, as a result, to make compound results too.”
So, how can I start investing?
Doggett said approaching investing might seem like a daunting experience, especially if you were new to it.
Step 1: Be comfortable
“The first step is to make sure that you are investing in a way you are comfortable with,” he said.
“Once you’ve decided that investing is for you, consider which investments align with what you want to get out of the process carefully. Find some things that match your appetite for risk and remember that each investment is just part of your overall portfolio, so be sure to think about what the bigger picture is as you add parts to it.”
Step 2: Find the right balance
Next, work out how much you’d like to put into shares. Starting with even just $5 can make a difference through compound returns over time.
“Dollar-cost averaging is a great tool to get started, choosing a set amount per week, fortnight or whatever works for you to automatically transfer into your investments,” Doggett said.
“It’s important to be realistic about what’s a good amount for you – high enough to make a difference but low enough that you can let your investments do their thing over time to make the most of compound returns without having to dip in and out of the pot if you’re missing your weekly coffee too much.”
Step 3: Keep up with your investments
Dogget said while it could be tempting to set and forget, you wouldn’t want to completely neglect your investments.
“Your risk appetite may change, or you may have a fluctuation in spending or your income – these will feed into how much and what you invest in,” he said.
“Keep this in check to make sure your investments are working as hard as they can for you, without compromising any of your wider financial goals.
“Most importantly, it’s never too late to start investing and time in the market is your friend.”
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