What is Compound Investing?
Compound Investing is how the Rich Get Richer. If you are looking to create real wealth and generate a larger income, Compound Investing is the key to making that happen.
Rich people or people who are working to create wealth buy businesses and invest in areas to create wealth (Assets). Poor people take their money and invest it in areas that cost money (Liabilities). This isn’t a new concept but it is by far the most important concept to fully understand when learning how to improve your investments.
Compound Investing starts as one investment, then two, then three and so on. Each additional investment creates more value and can generate more income for the investor. The trick to accelerate your investments is to have your investments generate additional investments rather than continually taking money from your pocket and adding investments.
If your Investment is Making Money How come it isn’t Generating Additional Investments?
There is a strategy behind Compound Investing and the more creative you are with your investments, the more potential you have to generate a higher income. There are millions of ways to generate income. The more income sources you have the more money you will make.
Seems obvious but the vast majority of us fall into a one or maybe two-income bracket that doesn’t generate the amount of money needed to become rich. So by being creative in how we are making new income sources, you will start to have 3… 4….7 income sources all generating money for you to live or reinvest into other income sources. Each new income source will start generating more and more income as time goes on.
How Does Compound Investing Work?
Compound investing is having your investments create income that can be used to acquire more investments while still controlling the original Asset.
After creating another Asset the cycle starts again now with an additional investment. By continually adding investments that are generating more income you create a self-propelled Asset generating machine to financial freedom.
Conventional investing is how most of us were taught to invest our money. The vast majority of individuals and families invest by taking money out of their pocket and stashing it away into investments such as Mutual Funds, RRSPs, Stocks, Bonds, and the list goes on.
Like I said before, there are thousands of ways to invest and some are better than others and some are riskier than others.
Using Compound Investing is a strategy.
This strategy has been used for a long, long time by a lot of great investors. Some programs/strategies already exist and can be followed as well. One of these strategies is named the “Dogs Of The Dow”. The Dogs Of The DOW is an investment strategy that was popularized by Michael B. O’Higgins in his book “Beating The Dow” in 1991.
The Dogs Of The Dow strategy is to look at all of the companies inside the DJIA (Dow Jones Industrial Average) and select the top 10 companies with the highest dividend payout relative to stock price. By investing in the 10 highest Dividends yielding Stocks the Dogs Of The Dow have created a system where they benefit if the stock prices go up as well as get a return on their investment through dividends. The investor then reinvests the dividend payouts and acquires more shares and more shares as time continues.
What this means is, if you like to invest in the stock market and most of your holdings are in mutual funds or maybe you like the stock market but you have your investment broker doing the trading for you and you don’t know exactly where your money is. If you were to change your strategy for growth to involve more dividends your investments will grow not just in stock price but they will now generate Cash returns from the dividend payouts.
You can then reinvest your dividend income back into the Stock market and now your Assets have generated new Assets and you can take advantage of the increase in Stock price on both as well and continue to get the dividend payout from the original Asset.
This cycle continues on and on and you generate more and more Assets as time goes by. If you focus your investment more into cash flow rather than on total value you can constantly be buying new Assets to generate even more cash flow.
Cash flow vs. capital gain
Cash flow is the name of the game for Compound Investing. Creating cash flow can be difficult but isn’t always difficult, as much as time-consuming. A lot of times to create the cash flow you will be “working for free” for a while until the money starts to slowly trickle in gaining momentum faster and faster as you continue to do more work. The determination to continue to work knowing that the end goal of cash flow takes time is what will make you successful.
Creating cash flow isn’t always difficult either. You could simply purchase a rental property. There will be some work “without pay” buying, renovating, getting a good tenant but the money will come and the cash flow will start to roll in.
Creating good cash flows that generate money without you directly getting paid based on an hourly basis such as the 9-5 job will let you expand your income through multiple streams rather than tying up your time for a specified amount of cash flow.
Creating Cash flow is all about creating a constant flow of money into your accounts.
The flip side of the coin is Capital Gains. Capital gains are using appreciation or increasing the potential value of something and liquidating it for the profit. Whether this is a Business, a Property,
Stocks, RRSP, etc. The list of Assets that are only for Capital Gains is a big one and most of them are easy to get into such as RRSP’s or Stocks.
The problem with Capital Gain Assets is you can’t create Compound Investments. The reason you can’t create Compound Investments with Capital Gains is that to get the money out of the Asset you have to sell it. With Compound Investing you want to get the money from the Asset and keep the original Asset. Taking the income from that Asset and creating a 2nd. These 2 Assets then create a 3rd and a 4th, 5th 6th and so on.
If you purchase a property to get Capital Gains you would; find a good deal, fix it up and sell it to make a profit. But while you can make money doing this you have to continually acquire, fix and sell properties. Each property has a onetime sale value and then it’s gone.
Whereas, if you purchase a property, fix it up and rent it out, you can start generating an income of $500 per month for years without having to do a whole lot of work to maintain that income. You also won’t be getting paid for hours worked like the 9-5 you are used to. Getting paid “X” dollars an hour is OK but with the rental income, you get paid because you provide a service to the tenant, not on an hourly basis.
Types of Compound Investments
There are thousands of ways to make money if you can be creative with potential investments. Being creative will help you make new and better revenue streams, but how do you start? These are some of the investments that are commonly used for creating Cash Flow.
- Real estate
- Stock Dividends
- Side Business
- Peer to Peer Lending
Using real estate for cash flow can be very lucrative. By studying how Millionaires created their wealth, you will find that the vast majority of them have investments in Real Estate. This may be a rental property, a storage facility, office space, etc. The list never ends. If you get a Real Estate property and find a way to generate cash flow from it, your Real Estate can buy more Real Estate and start the Compounding process.
One of the best things about Real Estate is the simplicity, the potential to leverage a bank or lender to increase your returns and the control you have over how much income it can generate. By Leveraging a Bank or Lender you don’t have to have all of the money to invest like you would for stocks or in an RRSP. But, you still get the income as if you did have all that cash sitting around.
Dividends are a payout from Stocks you have purchased that are based on the company’s revenue. A lot of times you can get a Dividend payout multiple times a year from a single Stock. So when you have multiple Stocks paying Dividends such as in the “Dogs Of The DOW” strategy you can create a Dividend income all year long.
The good part about Dividend-paying Stocks is you get the appreciation in value that the Stock market offers as well as the Cash Flow while still maintaining liquidity. The downside is that you need a lot of cash to create a good Cash Flow from Dividend stocks.
To create a $50,000 a year in Dividend Cash Flow, you would need $1,000,000 in Dividend-paying Stocks with an average Dividend yield of 5%. That’s a lot of cash invested into Dividend Stocks.
The highest rate of Return on Investment (ROI) typically will always be a business. This is why rich people buy businesses and other cash-generating Assets. The downside is that businesses can require a lot of time and energy to get the momentum going. That’s why you need to be creative and come up with a side business.
A small business that you can run “in the background” of daily life can be a great way to start generating income for your future investments.
Find a way to make money while you sleep and you can replicate it to create more and more income indefinitely. Side hustles as they can be called can create an income and allow you to live off your paycheque while still investing money into your retirement.
Keep your day job and start a side business today. Use the income from a side business to fund your investments creating more and more cash flowing investments. By making a plan like this the road to wealth will get easier and easier as your cash-generating machine grows.
Buying a franchise can be expensive but you can work with other investors to help supplement the potential investment. The great part about a franchise is that you can use their infrastructure to your advantage. As the franchise advertises and the franchise grows your business will grow alongside it. Franchises have a great way of getting things set up and working to create good efficient businesses. This means you can hire out the managers and other positions to get the cash flow and limit your time investment.
Peer to Peer Lending
Peer to Peer lending has been getting very popular over the past number of years. It makes sense too, you can use investment platforms to pool your money together with a lot of other investors and allow people to borrow with interest. Some of these platforms allow you to invest as little as $25 in a lot of different investments. This can help to lower your risk of losing money because you can spread your money over many, many investments.
Why starting Compound Investing is difficult for a lot of people
According to stats Canada “Median after-tax income of Canadian families and unattached individuals rose 3.3% to $59,800 in 2017”.
Also, Global News reported,
“The household-debt-to-income ratio edged down to 177.1 percent in the second quarter of the year, from 177.5 percent between January and March. The numbers mean Canadian owe $1.77 in debt — including mortgages and consumer debt like credit cards — for every dollar of disposable income.”
These 2 stats show a picture of why it is so difficult for Canadians to come ahead. When the average Canadian owes $1.77 in debt for every dollar of disposable income and families with multiple earners and generating an average household income of only $59,000 it can be hard to save and make good investments.
It is possible to come out ahead of the game. You start small and make a difference one piece at a time. The hardest challenge is getting started. Don’t think about making $1000, think about making $1 a 1000 times. It’s much easier to make $1 than $1000 all at once. Every little piece makes a difference. Start with $1. Turn it into $2 then $3 and so on. Then sit back and watch the machine grow.
If you want to change your world write it down. When you write what you want down you have made your goal real and now you can start to work toward the completion.
Learn to make proper goals and investments. Don’t forget to use all the advantages you can to create your Asset generating machine toward Financial Freedom.