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This guide explains the power of compounding and what you miss out on by trying to time the market when investing, and how this can accelerate returns over time.
Most investors try to time the market in the hope that they can buy low and sell high to maximise investment returns. However, in reality, stock market predictions may not be very accurate, and past performance is no guarantee of future returns.
While history can't tell you when these periods will occur, it does show that financial markets eventually recover from market volatility.
Compounding refers to the ability of an investment to generate earnings not only on the principal amount but also on the accumulated interest over time. As a result, the power of compounding can turn a small initial investment into a significant amount of wealth in the long term.
Compounding can work for any investment type but it requires time, patience and discipline to achieve its full potential.
Imagine you invested $1,000 in global stocks every month for 20 years. Sometimes you'd buy at the lowest price of the month, and other times at a higher price. Over time, the difference between buying low and selling high would average out. The end result would be very similar.
Now, compare that to an investor who waited for the 'perfect' time. They didn't start investing until prices were especially low. They also managed to buy at the lowest prices each month after that. Despite this great timing, their final outcome could be worse. Why? Because by waiting, they ended up investing less money over the years and missed out on the growth that comes from compounding.
Starting earlier meant more contributions and more time for that money to grow. That extra time in the market – and not 'perfect timing' – made the real difference.
If your aim is to grow your wealth over the long term, starting to invest sooner, rather than later, is usually more important than trying to invest opportunistically.
If you're nervous about investing a lump sum, you can split the amount and make regular investments. Regular investing helps smooth out the effects and fear of market movements.
More shares are purchased when prices are lower, and fewer shares are purchased when prices are higher. This approach can help you stay with an investment plan by reducing the impact of short-term market movements on your portfolio.
To help you make steady progress towards your long-term investment goals, you can set up a recurring investment plans with fund managers and investment service platforms. HSBC WorldTrader offers recurring investment plans on US and Canadian exchanges.
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