Many of us would have heard about Superman, a fictitious TV character with superhuman powers. He can fly, see through walls, move mountains… but he has one weakness, and that is kryptonite. Kryptonite is an element from outer space that cripples Superman making his powers useless.

When it comes to investing, many of us want our money to multiply fast… which is why many flock to cryptocurrency. It’s kind of like buying a lottery ticket and trying to multiply our money very quickly. For those who’ve done it successfully, good on you. But for me, I can’t imagine building my entire financial strategy based on it. I’m not willing to take the punt because the risk outweighs the gains.

Instead, I believe in establishing a foundation of building wealth through compounding returns. This is the whole idea of getting rich slowly where there’s far more certainty.

Compounding returns is when the growth made on your initial investment starts to compound, and over time it makes more money for you.

Compounding returns essentials

1. Start as early as possible – time is your friend when it comes to investing.
2. Invest as regularly as possible – establish your surplus cash flow and put it into long term investments regularly.

Start as early as possible

Imagine you place $10,000 into an investment and that investment generates a return of 10% in a year. After the first year it’s no longer $10,000, you now have $11,000. Your initial investment has grown. In the next year, you’re getting another 10%, but not just on your original $10,000, but on the additional $1,000 generated in the first year that you didn’t put in. So, it’s this idea of getting a return on your interest, in other words, growth on the growth… then after time it becomes growth on growth, on growth, on growth. Over even more time a critical mass occurs and suddenly the growth that you’re getting from the investment is coming from the investment returns, as opposed to what you originally put down. And this is where the whole theory of this is extremely powerful. The earlier you start, the more you’ll make.  

Invest as regularly as possible

Now what happens if we add more money regularly into this investment? Let’s say our initial investment is $10,000 and we add an additional $1,000 per month over a 30 year period at a modest 7% annual return on investment. After 30 years our investment is approximately $1.2 million. That’s incredible. It’s the whole idea of getting rich slowly.

Now let’s play around with the numbers a bit. Imagine our 7% return on investment increases to 10%. It doesn’t sound like a huge increase but over 30 years, instead of getting $1.2 million we now have $2.1 million. Just by tweaking that investment return, the power of compounding returns is having an even greater effect.

Return on investment

So you might be thinking, what investments will get me a consistent 7% (or 10%) return in the long run? Especially with the potential of the market crashing and a looming recession. Looking back historically on the Australian market 30 years ago, if you used an index fund or ETF fund and invested in the top 300 stocks on the Australian share market, you would have made 10% each year. If you started with $10,000 and invested $1,000 per month, you would have $2.1 million today. So, this concept is not just theoretical, it actually happened.

This is all easily said, but when you’re in the moment, skill and resilience comes into play. This is where the kryptonite to building wealth comes in.

An investors kryptonite

Let’s put ourselves in the shoes of an Australian share investor 30 years ago. We can use hindsight to say there was a 10% growth however, there were good periods and also bad periods. Investing in shares is not like placing your money in the bank where year on year, you’re getting interest and it never goes backwards. Cash in the bank is safe. You get more interest some years and less interest other years but for the most part your money never goes backwards.

Shares on the other hand are a bit bumpier, a lot more volatile… a lot more up and down. Looking back 30 years, 24 out of the 30 years saw positive growth, however there were 6 years where investments declined… 2002, 2003, 2008, 2009, 2012 and 2020. During these 6 years, do we sell and bow out to the decline? Do we throw in the towel? Or do we stay strong and hold our ground? Do we have the resilience? Do we have the perspective to stick to this in the long term to see the pot reach $2.1 million?

We are the kryptonite

I hate to say it, but the kryptonite is us. It’s our mindset… when we throw in the towel early rather than holding out for the long term. A few bad years can knock us around, giving us a reason to call it quits. Even though from the outset, we know what we’re working towards. We’ve done the math. This is what we want over a 30 year period, but somewhere through the journey in those six bad years out of 30, we panic.

We start to get nervous and we bail…that is the kryptonite, it’s you and it’s me. It’s our human behaviour getting involved and distracting us from that long term result that we’re going for.

Stay resilient

In the investment journey, focus on things we can control. The initial investment, regular investing and holding our ground. Don’t focus on things we can’t control like average return. Consider our behaviour through the investment journey. Are we going to be someone that’s going to try and predict? Or think we know better than everyone else? Or are we just going to focus on sticking at it, extract that average return, and see our pot reach that financial goal in the long run.

So… invest early, invest regularly and stay resilient. Don’t let the kryptonite of building wealth stop you from financial freedom.