Monday, 1 March 2010

Growing at 15% a year - what does this entail?

To achieve a 100% gain in your investment over 5 years, the initial capital has to grow at a compound rate of 15% per year. This means that an initial $100 investment will be worth:

$1.15 at end of year 1,
$1.33 at end of year 2,
$1.52 at end of year 3,
$1.75 at end of year 4, and
$2.01 at end of year 5.

Though the fund managers usually benchmark their fund performances to a certain index, most individual investors should look at the absolute return.

The return on your investment is unlikely to rise in a straight-line upwards. Volatility in the return is to be expected. The return spurts over certain times, declines over certain times, and remains unmoved over certain times.  However, the return over a long time is less volatile and generally relates to the earnings of the business of the invested stock.

What does 15% per year looks like in real-time? Excluding the dividend yield from the calculation, it is actually an average of 1.25% per month appreciation in the share price. The 15% may be returned in a consistent manner or there maybe periods of spurts delivering part or all the returns over many short periods. Do not get disheartened if a stock moves only 1% or 2% per month, it is the consistency in its return that adds to a big return. On the other hand, do not be overly excited by the big returns over a short period. For the long-term investors, it is more important that over a long time, the price of the stock reflects the improving earnings fundamentals of your selected stocks.

To double your initial investment in a stock in 5 years means also selecting a stock that will double its earnings in 5 years. For those who are directly in business, to grow a business consistently over many years is indeed very challenging. The matured large companies are less likely to deliver such growths. Therefore, for those investors seeking such growth rates in the earnings of their stocks, they will need to look at mid-cap stocks or smaller companies where growths can be faster in the early stages of their business life.

It is not difficult to make 7 or 8% returns yearly in your investment in stocks.  However, to grow at 15% or more, this can be very challenging indeed, but not impossible even for the non-professional investors.

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