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Thursday, September 25, 2008

Would You Like to be Rich?

Here is the single most important thing you will ever hear about investing: Getting rich is simple. Not easy, but simple. And here is the second most important thing you will ever hear about investing: You have no excuse not to do it.

Only three ingredients are needed: income, discipline and time. Chances are, you already have two of them, income and time. All you need to do is add the third, discipline. And armed with the following knowledge, that key third ingredient may be a lot easier to find. Here’s how it works:

Say you start with nothing, invest $500 of your income a month (a healthy discipline), and let your money ride over time in diversified investments. Long term, the stock market returns at least 10% annually. Assuming a 10% return, you’d have $102,000 after 10 years, $380,000 after 20 years, and $1.1 million in 30 years.

Here’s a similar scenario: If you start with a nut of $50,000 and add only $250 per month, you’d have $180,000, $516.000 and $1.4 million after 10, 20, and 30 years, respectively. All this happens through the power of regular investing and a simple-but-powerful concept called compounding. Yes, saving a bit over a long time is a sure way to growing your nest egg. Why? Because of the power of compounding. The piece goes on to explain this:

Compounding is the reinvestment of the interest you receive from the money you set aside. For example, if you invest $1,000 and earn 10% interest on your principal at the end of each year, you’ll get in $100 interest at the end of the first year. If you reinvest that interest, the second year you would start with $1,100, and thus would earn $110 interest. If you stay with it, you’d more than double your money every eight years.

“Compounding,” Albert Einstein said, “is mankind’s greatest invention because it allows for the reliable, systematic accumulation of wealth.” Einstein was a smart man. But you hardly have to be a genius to make this concept work for you. But you need more than compounding to help make the most of your money. The real magic of investing comes when you combine the surprising power of compounding with continuous and regular investments –in other words, discipline.

The best way to make these continuous investments happen is by setting up an account with a broker or mutual fund that automatically deducts a fixed amount from your bank account every month. “Automatic” is the operative word here. Trust me, if you don’t set it up that way, it won’t happen. Instead, you’ll end up pouring money in when the market is soaring and skipping payments when it’s heading down. Eventually you’ll get discouraged and give up.

The process of continuously investing a fixed dollar (rupiah) amount is called dollar-cost averaging –a term that sounds much more technical than it is. Through dollar-cost averaging, you’ll end up buying more shares when a stock or fund is down, and fewer when it’s up. For instance, say you’re investing $500 monthly in a stock trading initially at $50 per share; so the first time, you buy 10 shares. If the next month the stock moves up to $62.50 your regular purchase will net you only eight shares. However, if the stock drops to $41.67, you’ll get 12 shares (not including any transaction fees).

It’s easy to set up regular-investment mechanisms, thus harnessing the power of dollar-cost averaging. Mutual funds are the traditional way. But there are other outlets, as well, that allow you to apply the strategy with individual stocks or exchange-traded funds, which are baskets of stocks that identically track standard market indexes, such as the Indeks Harga Saham Gabungan (IHSG) or Dow Jones Industrial Average (DJIA).

Of course, if you prefer to get rich in another way, there are options. You could win the lottery/jackpot, or pick the next McDonald Stores. But don’t quit your day job just yet. Your chances of winning big in the lottery run around 15 million to 1, at best.

Here’s the bottom line, like it or not: The fate of your retirement, your comfort in older age, probably lies in your commitment to the concepts laid out in the paragraphs above. For the vast majority of us, wealth creation is a slow, steady, and powerful process. The tortoise almost always beats the hare.



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