When targeting high returns from investing in shares, it’s unnecessary to take crazy risks. It may seem logical to pursue high-risk opportunities to make big percentage gains. But I see another way to achieve a decent outcome without flirting with ultra-speculative stocks.
I can harness the power of compounding with a diversified portfolio instead. Compounding smaller percentage gains over time can produce an impressive outcome. And that principle is a cornerstone of my approach to investing.
Compounding returns from investing in shares
Even this approach isn’t risk-free, of course. All shares carry an element of risk. However, I’m prepared to embrace some risk in pursuit of higher gains. Compared to saving cash, there’s the potential for better returns by investing in shares and share funds.
The annualised return of the general stock market is often quoted as a high single-digit percentage. And I like to use 7% as an example. So I could put my £2,000 into tracker funds that aim to mimic the performance of the general market.
If I can compound an average of 7% a year with trackers, the outcome would be decent. After 15 years the £2,000 would grow to just over £5,500. The overall return works out at 175%. But that’s short of the bigger outcome I’m looking for.
As with all share investments, this isn’t a guaranteed outcome. But it’s surprising how much small improvements in the annualised returns can boost the compounding outcome. I can target higher returns than the general stock market delivers by investing in the shares of carefully chosen individual companies.
Targeting higher annualised returns
I’d like to reach a 1,000% overall return, but I know I might not, even if I pick individual companies. So if I can compound an average of 10% a year, that would give me a return of around 350% in 15 years. And compounding an average of 15% annually would increase my original investment eight-fold.
But just say I did even better. The following table sets out what’s possible if I managed to compound an annualised return of 25% each year. Of course, achieving a return on my portfolio as high as that isn’t easy and it isn’t certain. But it’s possible. And aiming for decent compounded returns is probably a better strategy than pitching all my money into a single speculative, ‘crash or glory’ share. This table is also a good illustration of how compounding works.
|
Year |
Annualised Return (£) |
Total Return (£) |
Balance (3) |
|
0 |
– |
– |
2,000.00 |
|
1 |
500.00 |
500.00 |
2,500.00 |
|
2 |
625.00 |
1,125.00 |
3,125.00 |
|
3 |
781.25 |
1,906.25 |
3,906.25 |
|
4 |
976.56 |
2,882.81 |
4,882.81 |
|
5 |
1,220.70 |
4,103.52 |
6,103.52 |
|
11 |
4,656.61 |
21,283.06 |
23,283.06 |
|
15 |
11,368.68 |
54,843.42 |
56,843.42 |
The table shows that after 11 years of compounding annualised returns of 25% I’d end up with a balance just above the 1,000% return I’m looking for. But the remarkable thing about the process is how absolute returns accelerate in size over time.
If I keep compounding 25% for a further four years for a total period of 15 years, my balance would grow to almost £57,000. And on an initial investment of £2,000, that’s an overall return of more than 2,700%.
OK, I’m not expecting to be that successful all of the time. But I’m trying! When it comes to investing in shares, I think this illustration is a powerful incentive for me to work hard with my investment strategy and share-picking. I also reckon it’s important to keep a close eye on my portfolio and monitor the news flowing from the businesses behind my shares. And if any company starts to underperform my expectations, I should sell up and look for a better investment to replace it.