In this article you will find out more about:
How to Double Your Money
The Underestimated Power of Compound Interest
Rate of Return Needed for Doubling Your Money in 10 Years
How to Produce 7.5% Annualised Return on Investment
Historical Return Rates for Different Asset Categories in the US
S&P 500 Return for EU Investors during 2013-2022
Return of MSCI World Index Tracker for EU Investors during 2013-2022
Return of Global Equity Portfolio during 2013-2022
Backtesting Return of Equity Portfolios during Different Investment Periods
Doubling Your Money in 10 Years
Who does not dream of a way to double an investment effortless in about 10 years? Usually, that's what get-rich-quick scams promise to their victims. But is there a reliable way to double your money without betting on cryptocurrencies or playing lottery? The answer to this question is positive.
The Underestimated Power of Compound Interest
To double your money in around 10 years, your investment must generate a yearly return of around 7.5% (at 0.2% total expense - without taxes). Therefore, you simply have to buy and hold your assets while dividends are automatically reinvested in order to benefit from the powerful compound interest. What appears to be a straightforward and easy task turns out to be a real challenge for most investors since discipline over a lengthy period is key to success.
Looking at an example with a 7.5% annualised return, an initial investment of $10,000 would generate a profit of about $730 till the end of the first year, considering a yearly administration fee of 0.2%. This profit needs to be reinvested immediately in order to benefit from the compound interest again. Accumulating funds do this automatically free of charge - in case of owning the distributing version of a fund, the investor has to initiate the reinvesting. Till the end of the 2nd year the profit has accumulated already to $1,510 and so on and so forth. The longer the money remains invested, the steeper the appreciation curve will look like over the long run.
Compound interest is a powerful tool for building wealth over time as it can accelerate the growth of investments. However, keep in mind that the effect of compound interest is affected by the size of the investment, the interest rate, and the frequency of compounding. The longer an investment is held, the greater the impact of compound interest.
The illustration below shows the ideal case of the compound interest effect working in favor of the investor.
But how realistic is such a portfolio development? For that let's look at different asset allocations and run some backtesting, which means looking at different worst-case scenarios and how the portfolio performed during and recovered from such major drawdowns (e.g., financial crisis 2008/2009).
How to Produce 7.5% Annualised Return on Investment
For obtaining rates of return in the range of 7-8% p.a., investors have to consider equity for their asset allocation. Although there are asset categories which might yield higher than equities, over the long run they cannot keep up due to their significantly worse risk-return profile compared to equities.
Historical Return Rates for Different Asset Categories in the US
US investors could have generated an average yearly return of more than 9% by simply holding a low-cost index fund replicating the broad S&P 500 market index. For the period 2013-2022, the S&P 500's average annual return has increased to even 12.4% p.a. (in USD).
Below picture shows geometric average historical returns for different asset categories for USD-investors over three different holding periods. 3-month treasury bills generated the lowest return during all three holding periods while the S&P 500 (including dividends) performed best, followed by Baa rated corporate bonds.
S&P 500 Return for EU Investors during 2013-2022
For EU investors the compound annual growth rate for investments in a low-cost Vanguard S&P 5oo index fund with 0.07% expense ratio would have been even 14.89% (in EUR) between 2013 and 2022. While the longest drawdown period started in December 2021 and has been lasting for 1 year with a trough of -13.1%, the deepest drawdown period lasted for 7 months and was between January 2020 and August 2020. It reached a trough of -18.9%. That should explain the big challenge to keep discipline over a long period of time.
An investment of EUR 10,000 in the Vanguard S&P 500 index fund at the beginning of 2013 would have been doubled by November 2016, reaching a portfolio value of EUR 20,240. So, doubling your investment without lifting a finger achieved.
Return of MSCI World Index Tracker for EU Investors during 2013-2022
If EU investors bought at the beginning of 2013 the iShares Core MSCI World index tracker (TER 0.2%) and hold until December 2022, their investment would have generated a compound annual growth rate of 11.51% (in EUR). Longest drawdown period lasted for 1 year and 6 months (May 2015 - Nov 2016) with a trough of -12.4%. The deepest drawdown period lasted for 10 months and happened between January 2020 and November 2020. It reached a trough of -19.8%.
An investment of EUR 10,000 in the MSCI World ETF at the beginning of 2013 would have doubled the money by July 2018, so within 5.5 years' time.
Return of a Global Equity Portfolio during 2013-2022
Although the S&P 500 is a broad market index representing the 500 biggest US companies by market capitalisation, it is limited to the US only. Some investors might want to further diversify their portfolio to basically "own" the global economy instead of holding only one index tracker fund replicating the S&P 500 or the broader MSCI World index. This approach allows to adjust individually the weighting of certain economic regions - for example, to reduce the overweight of the US market within the MSCI World index. Over time, such an individualised portfolio allocation requires some rebalancing from time to time to reduce allocation drifting towards outperforming regions. This regular portfolio rebalancing can contribute positively to the risk and return profile of a portfolio, as explained in more detail in the blog article "Importance of Investment Portfolio Rebalancing and its Impact on Performance".
As alternative, the following allocation represents a major part of the global economy via six low-cost ETFs:
38% North America - Vanguard FTSE North America UCITS ETF Distributing
20% Europe - Vanguard FTSE Developed Europe UCITS ETF Distributing
20% Emerging Markets - Vanguard FTSE Emerging Markets UCITS ETF Distributing
7% Japan - Vanguard FTSE Japan UCITS ETF Distributing
5% Asia Pacific ex Japan - Vanguard FTSE Developed Asia Pacific ex Japan UCITS ETF Distributing
10% Global Small Cap - SPDR MSCI World Small Cap UCITS ETF
As for the S&P 500 investment, let's assume the investor is putting EUR 10,000 to work at the beginning of 2013. Without rebalancing to the initial weighting of the portfolio allocation, the global portfolio would have generated for the European investor compound average growth rate of 10.28%. A simple buy and hold approach with reinvesting dividends into the portfolio would have doubled the initial investment amount of EUR 10,000 by April 2019 (EUR 20,250).
For the global equity portfolio, the longest drawdown period lasted for 1 year and 6 months (between May 2015 and November 2016) with a trough of -16.4%. The deepest drawdown period lasted for 11 months (between December 2019 and November 2020). It reached a trough of -21.0%.
Backtesting Results: Return of Equity Portfolios during Different Investment Periods
Was it simply luck to achieve such strong returns? Certainly, the odds are not bad for doubling your initial investment within 10 years when looking at the different equity portfolios. For the S&P 500, doubling your initial investment within 10 years worked well for all below shown investment periods. The globally diversified MSCI World index tracker failed to achieve the doubling of the initial investment within 10 years during two periods (starting in Jan 2006 and Jan 2007). The drawdown was obviously too extreme during the financial crisis for recovering fast enough to achieve the desired result. The better diversified Global Equity Portfolio was slightly better and missed in only one case to double the investment within 10 years' time. Although the S&P 500 has worked best in the selected investment periods for doubling the invested money within 10 years, from a diversification point of view the other asset allocations would have been more beneficial. For more on diversification benefits please refer to the article Why Portfolio Diversification matters even more nowadays.
But investors should be cautious and always bearing in mind, that the outcome refers to only very few investment periods (e.g., the starting point for all investments (except for 2005) was at the beginning of the respective year). Results will differ if other entry points were chosen, or additional cash injections were made during the investment period. Also, past performance is never a guarantee of future returns.
However, instead of taking undesired risks by purely focusing on aggressive asset growth rates and neglecting basic diversification rules, investors should rather look at risk return profiles for different asset allocations across different asset categories to benefit from lower volatility due to less correlated asset types.
For those who are interested in more scenarios for portfolios based on index tracker funds (ETF), websites like curvo.eu or portfoliocharts.com could be a fantastic source. Both offer various options to run comprehensive backtest scenarios which help to better understand potential risks linked to investing into a certain portfolio.
Disclaimer: The scenarios or investment products presented above should not be construed as investment advice. All investments involve some level of risk, and past performance is never a guarantee of future returns. As always, do your own research in order to validate and better understand the underlying risks.
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