Everybody knows who Warren Buffett is. The greatest investor of all time of course. Even at 91 Buffett is wealthier than ever, what's the key to his success? Time. When it comes to investing most people think that you have to time the market correctly to make money but it's actually much simpler than that. The key to Buffett's wealth is not "timing the market" it is "time in the market". Buffett has been investing since he was 15 years old and that is a long time to be in the market.
When it comes to investing sometimes it gets over complicated. You'll see articles that say "buy these 5 stocks now" or "invest in these stocks now to be a millionaire by x years". Although there may be some truth to those articles, the real truth is "time in the market".
What Does Time In The Market Mean?
We commonly confuse timing the market with time in the market. Timing the market will create bad investing habits and likely cause you to be chasing gains. This is because an investor will try to time their investment when the market crashes or there is a sudden dip in a stock however we can't always rely on a market crash or a dip in a stock. That's why time in the market is the best way to invest. The proper term for this is Dollar cost averaging.
Dollar Cost Averaging
Dollar cost averaging is when an investor invests into a specific stock or fund over a period of time. A great example of this is a 401(k). When you get paid a portion of your check gets contributed to your 401(k). Each week you get paid the portion contributed to your 401(k) is invested at the current price the fund is trading at. There are a few good reasons why dollar cost averaging is a great way to invest in the stock market. The first is, it doesn't require waiting for the dip. In fact, if you dollar cost average in your investment account each week you will buy the the dip and never miss out. The second reason dollar cost averaging is so effective is because of compounding interest.
Compounding Interest
Warren Buffett got it right early. The reason his returns have grown exponentially is because of compounding interest. When investing at a young age he learned that his returns would compound growing them exponentially through the years. Compounding interest is interest paid on a principal amount.
The power of compounding interest can be explained in this visual.
Lets take for example you buy $10,000 of SPY (S&P 500 index fund)
The fund returns an average of 10.5% each year.
Target retirement date: 65
In the first scenario an individual begins to invest $10,000 at the age of 20 years old. The value of the portfolio after 45 years of compounding has grown to $893,927.94. In the second scenario an individual decided to wait until the age of 35. The value of their portfolio after 30 years only grew to $199,925.57. The individual who decided to invest at an early age ended up with 4.5 times more at retirement than the individual who invested later on in life.
Dividend Reinvestment Program
Another great way that compounding works in your favor is through dividends. Many publicly traded companies offer shareholders dividends. Dividends are typically paid out quarterly. What's great about dividends is you can reinvest them back into the stock. This is done through a Dividend Reinvestment Program or DRIP. This allows you to continue to build that snowball and keep compounding your money.
Rule of 72
The rule of 72 is a great tool for you to calculate how long it will take you to double your money based on the rate of return. This is tool to map out how long you need to be invested to see your money double.
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