One of the advantages associated with long-term investing is the potential for compounding. Here’s how it works: When your investments produce earnings, those earnings get reinvested and can earn even more. The more time your money stays invested, the greater the opportunity for compounding and growth. Keep in mind that while compounding, overall, can have a significant long-term impact, there may be periods where your money won’t grow. While there are no guarantees, the value of compounded investment earnings can turn out to be far greater over many years than your contributions alone.
By starting to save early you can benefit from the power of compounding, whereby the earnings of your account earn additional earnings. Over the course of decades, this can make a significant difference.
Take the example of two co-workers — Jill and Edwin. They saved the same amount of money in their firm’s retirement plan ($100 a month for 20 years for a total of $24,000) and earned the same annual return (8%). The only difference is that Jill began investing at age 36, and Edwin waited until he was 46. The bottom line: By age 65 Jill had accumulated $131,613 while Edwin’s balance was $59,295. That’s a significant advantage for Jill, thanks to getting an early start.1
In general, it’s a poor idea to attempt to time the markets. Too often, investors are spooked by a stock market downturn and flee the market. This can lock in losses and prevent investors from reaping the rewards when the market rebounds.
For example, let’s take a look at the 10-year period following the 2000-2002 stock market decline of 49.29%. An investor who invested $1,000 and had the courage to stay put would have realized an average annual return of 6.38%, ending up with a balance of $1,856. However, an investor who invested $1,000 and then missed just the 10 best days over the following 10-year period would have ended up with $938, for a loss of 6.2% in value. You may hear a lot of talk about timing the market, but successful investing is more about time than timing.1
No one has figured out the best time to invest. You can take the guesswork out of it by making a regular fixed-dollar investment, for example, every month or every paycheck. This is called dollar cost averaging. If you’re contributing to your retirement plan, you’re probably already using this strategy.
Because the prices of mutual funds fluctuate, dollar cost averaging allows you over the long term to:
Dollar cost averaging can lower your average cost per share of a mutual fund, but it doesn’t guarantee a profit or protect against loss. You should consider your willingness to keep investing when share prices are declining.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.