If I Could Tell All Long-Term Investors Just 1 Thing Right Now, It's This
Key Points
Compound earnings occur when the interest you earn on investments begins to earn interest on itself.
Compound earnings are responsible for turning everyday investors into eventual millionaires.
An S&P 500 ETF is a great passive investment that can make staying consistent easier.
- 10 stocks we like better than Vanguard S&P 500 ETF ›
There's never a shortage of investing advice floating around. Some is great, and some is not so great. But one thing that most great investing advice has in common is that it has passed the test of time. Some advice is only relevant for the moment.
If I could reiterate one piece of timeless advice for long-term investors, it's this: Don't underestimate the power of compound earnings. It's the greatest wealth-building engine in the financial world, and it's why many everyday investors become millionaires.
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What exactly are compound earnings?
Compound earnings happen when the profit you make on investments starts making profit on itself. It's your money making money without any extra effort.
For example, if you invest $1,000 and earn a 10% annual return, that's $100. If you reinvest the $100, your next 10% return is on $1,100, earning you $110. Fast forward 20 years, and you're earning 10% on $6,116, after only originally investing $1,000.
It's not a get-rich-quick process, but it's as foolproof as it comes.
Image source: Getty Images.
Use the S&P 500 as your passive ticket
The best way to take advantage of compound earnings is to invest consistently, and one way to help ensure that is to have an investment you don't necessarily have to think about. You can truly treat it as a set-it-and-forget-it investment.
For most investors, that's an S&P 500 exchange-traded fund (ETF). My personal go-to is the Vanguard S&P 500 ETF (NYSEMKT: VOO), but there are a few to choose from. VOO checks a few boxes: diverse, cheap, and, most importantly, proven to work. Here is how much it has averaged annually over different numbers of years.
| 3-Year Average Annual Returns | 5-Year Average Annual Returns | 10-Year Average Annual Returns | Average Annual Returns Since Inception |
|---|---|---|---|
| 22.4% (23.8%) | 12.5% (14%) | 13.7% (15.6%) | 8.3% (11%) |
Data source: YCharts. Total Returns in parentheses. Returns as of market close on Oct. 6.
For the sake of illustration, let's assume VOO continues to average the 11% annual total returns it has since its inception. Below is how much $500 monthly investments would grow over different numbers of years.
| Years Invested | Personally Invested | Investment Total |
|---|---|---|
| 20 | $120,000 | $383,800 |
| 25 | $150,000 | $683,300 |
| 30 | $180,000 | $1.18 million |
Table by author. Investment totals account for VOO's expense ratio and are rounded down to the nearest hundred.
Past results never guarantee future performance, so there's no surefire way to say what the S&P 500 will average going forward. However, the larger point is how compound earnings can take relatively modest investments and turn them into much more over time.
It can be hard to focus on a decade or more down the road, but the more you keep it in mind, the more you'll use time to your advantage and maximize it.
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Stefon Walters has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
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