5 Ways To Double Your Investment
5 Ways To Double Your
Investment
By Ken Clark
There's something about the idea of doubling
one's money on an investment that intrigues most investors. It's a badge of
honor dragged out at cocktail parties, a promise made by over-zealous advisors,
and a headline that frequents the cover of some of the most popular personal
finance magazines. Where this fixation comes from is anyone's guess.
Perhaps it comes from deep in our investor
psychology - that risk-taking part of us that loves the quick buck. Or maybe
it's simply the aesthetic side of us that prefers round numbers - saying you're
"up 97%" doesn't quite roll off the tongue like "I doubled my
money." Fortunately, doubling your money is both a realistic goal that
investors should always be moving toward, as well as something that can lure
many people into impulsive investing mistakes. Here we look at the right and
wrong way to invest for big returns.
The Classic Way - Earn
It Slowly
Investors who have been around for a while will
remember the classic Smith Barney commercial from the 1980s, where British
actor John Houseman informs viewers in his unmistakable accent that they
"make money the old fashioned way - they earn it." When it comes to the most traditional way
of doubling your money, that commercial's not too far from reality.
Perhaps the most tested way to double your money
over a reasonable amount of time is too invest in a solid, non-speculative portfolio that's diversified between blue-chip stocks and investment grade bonds. While that portfolio won't double in a year, it almost
surely will eventually, thanks to the old rule of 72.
The rule of 72 is a famous shortcut for
calculating how long it will take for an investment to double if its growth
compounds on itself. According to the rule of 72, you divide your expected
annual rate of return into 72, and that tells you how many years it takes you
to double your money.
Considering that large, blue-chip stocks have
returned roughly 10% over the last 100 years and investment grade bonds have
returned roughly 6%, a portfolio that is divided evenly between the two should
return about 8%. Dividing that expected return (8%) into 72 gives a portfolio
that should double every nine years. That's not too shabby when you consider
that it will quadruple after 18 years.
The Contrarian Way - Blood in the Streets
The 'Rule of 72' is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a rough estimate of how many years it will take for the initial investment to duplicate itself.
For example, the rule of 72 states that $1 invested at 10% would take 7.2 years ((72/10) = 7.2) to turn into $2. In reality, a 10% investment will take 7.3 years to double ((1.10^7.3 = 2).
When dealing with low rates of return, the Rule of 72 is fairly accurate. This chart compares the numbers given by the rule of 72 and the actual number of years it takes an investment to double.
The Contrarian Way - Blood in the Streets
Even straight-laced, even-keeled investors know
that there comes a time when you must buy - not because everyone is getting in
on a good thing, but because everyone is getting out. Just like great athletes
go through slumps when many fans turn their backs, the stock prices of
otherwise great companies occasionally go through slumps because fickle
investors head for the hills.
As Baron Rothschild (and Sir John Templeton)
once said, smart investors "buy when there is blood in the streets, even
if the blood is their own." Of course, these famous financiers weren't
arguing that you buy garbage. Rather, they are arguing that there are times
when good investments become oversold,
which presents a buying opportunity for brave investors who have done their
homework.
Perhaps the most classic barometers used to
gauge when a stock may be oversold is the price-to-earnings ratio and the book value for a company. Both of
these measures have fairly well-established historical norms for both the broad
markets and for specific industries. When companies slip well below these
historical averages for superficial or systemic reasons, smart investors will
smell an opportunity to double their money.
The Safe Way
Just like how the fast lane and the slow lane on
the freeway eventually lead to the same place, there are both quick and slow
ways to double your money. So for those investors who are afraid of wrapping
their portfolio around a telephone pole, bonds may provide a significantly less
precarious journey to the same destination.
But investors taking less risk by using bonds
don't have to give up their dreams of one day proudly bragging about doubling
their money. In fact, zero-coupon bonds (including classic U.S. savings bonds) can keep you in the "double your
money" discussion.
For the uninitiated, zero-coupon bonds may sound
intimidating. In reality, they're surprisingly simple to understand. Instead of
purchasing a bond that rewards you with a regular interest payment, you buy a
bond at a discount to its eventual maturityamount. For example, instead of paying $1,000 for a
$1,000 bond that pays 5% per year, an investor might buy that same $1,000 for
$500. As it moves closer and closer to maturity, its value slowly climbs until
the bondholder is eventually repaid the face amount.
One hidden benefit that many zero-coupon
bondholders love is the absence of reinvestment risk. With standard coupon bonds, there's the
ongoing challenge of reinvesting the interest payments when they're received.
With zero coupon bonds, which simply grow toward maturity, there's no hassle of
trying to invest smaller interest rate payments or risk of falling interest
rates.
The Speculative Way
While slow and steady might work for some
investors, others may find themselves falling asleep at the wheel. They crave
more excitement in their portfolios and are willing to take bigger risks to
earn bigger payoffs. For these folks, the fastest ways to super-size the nest
egg may be the use of options, margin or penny stocks.
Stock options, such as simple puts and calls, can be used to speculate on any company's stock. For
many investors, especially those who have their finger on the pulse of a
specific industry, options can turbo-charge their portfolio's performance.
Considering that each stock option potentially represents 100 shares of stock,
a company's price might only need to increase a small percentage for an
investor to hit one out of the park. Be careful and be sure to do your
homework; options can take away wealth just as quickly as they create it.
For those who want don't want to learn the ins
and outs of options but do want to leverage their faith (or doubt)
about a certain stock, there's the option of buying on margin or selling a
stock short. Both of these methods allow investors to essentially borrow money
from a brokerage house to buy or sell more shares than they actually have, which
in turn can raise their potential profits substantially. This method is not for
the faint-hearted because margin calls can back your available cash into a
corner, and short-selling can theoretically generate infinite losses.
Lastly, extreme bargain hunting can quickly turn
your pennies into dollars. Whether you decide to roll the dice on the numerous
former blue-chip companies that are now selling for less than a dollar, or you
sink a few thousand dollars into the next big thing, penny stocks can double
your money in a single trading day. Just remember, whether a company is selling
for a dollar or a few pennies, its price reflects the fact that other investors
don't see any value in paying more.
The Best Way to Double
Your Money
While it's not nearly as fun as watching your
favorite stock on the evening news, the undisputed heavyweight champ of
doubling your money is that matching contribution you receive in your employer's retirement plan. It's not sexy and
it won't wow the neighbors at your next block party, but getting an automatic
50 cents for every dollar you deposit is tough to beat.
Making it even better is the fact that the money
going into your 401(k) or other employer-sponsored retirement plan
comes right off the top of what your employer reports to the IRS.
For most Americans, that means that each dollar invested really only costs them
65 to 75 cents out of their pockets. In other words, for every 75 cents, most
Americans are willing to forgo out of their paychecks, they'll have $1.50 or
more added to their retirement nest egg.Before you start complaining about how
your employer doesn't have a 401(k) or how your company has cut their
contribution because of the economy, don't forget that the government also
"matches" some portion of the retirement contributions of taxpayers earning
less than a certain amount. The Credit for Qualified Retirement Savings
Contribution reduces your tax bill by 10 to 50% of what ever you contribute to
a variety of retirement accounts (from 401(k)s to Roth IRAs).
If It's Too Good to Be
True …
There's an old saying that if "something is too good to be
true, then it probably is." That's sage advice when it comes to doubling
your money, considering that there are probably far more investment scams out
there than sure things. While there certainly are other ways to approach
doubling your money than the ones mentioned so far, always be suspicious when
you're promised results. Whether it's your broker, your brother-in-law or a late-night infomercial, take
the time to make sure that someone is not using you to double their money.
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