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Investment and investment period

Investment and investment period

In principle, investment success and the investment period are very much dependent on one another when it comes to investing money. Therefore, at the beginning of an investment, the holistic view of the assets is always in the foreground. The following questions arise: How long can the money be invested? How much of the invested money should be available when? When and for what could the money be needed, or should the money be used regularly to supplement the pension? Is the interest needed for subsistence, or can it be reinvested? Are interim price losses tolerable? Would a total loss of the investment be economically acceptable?

In principle, the following definition of investment periods has become accepted: a short-term investment period is up to one year, a medium-term investment period is 1 to 5 years, and a long-term investment period extends over more than 5 years.

The longer the investment period, the higher the expected return and the lower the investment risk in terms of price fluctuations. The so-called “Rule of 72” has proven to be an illustrative rule of thumb for calculating interest. It says that if you divide the number 72 by the interest rate, the amount of interest on the investment per year (or the annual return on a portfolio) expressed as a percentage, the result is the number of years in which the investment will double in value. For example, the investment has an interest rate of 8% (or earns an annual return of 8%). 72 divided by 8 equals 9. So that means that at 8% return per year, it will take about 9 years to double the investment. At a 4% return, this would be 18 years, and at a 10% return, 7.2 years. This gives investors a sense of how interest rates or returns are related to the investment period.

If we now look at the average returns achieved in the stock market over the last 30 years, we can see that for the DAX, for example, the returns have been around 7-10% (depending on the calculation method) per year. In the American markets, for example in the S&P 500 or the technology-heavy NASDAQ, it was even significantly more than 10%. According to the Rule of 72, an average return of 10% per year means a doubling of the investment after a good 7 years. No other asset class has been able to beat the return of equities in the long term in the past! And that with a manageable risk. Only those who invested in the DAX in 2001, exactly at the time when the airplanes crashed into the Twin Towers in New York, had to wait for 6 years until the stock investment yielded profits. At all other times in the last 30 years, the loss stretches have been much shorter, or profits have usually been generated immediately.

Last but not least, let’s look at the greatest ally of the long-term investor, and that is the compound interest effect. This is an interest on the already credited interest from a previous investment period. The interest received in one period is always invested for the following investment period and also earns interest. Since the reinvested interest thus increases the investment, the result is that the interest income is also higher each year. For an investor, this is an opportunity to increase assets that should not be underestimated, whereby distributions or dividends from funds are also suitable for this purpose.

A long-term horizon is also crucial for compound interest. For compound interest to grow noticeably, it requires patience. The investment period should ideally be 10, 15 or more years, because the curve in compound interest is exponential. For an investment of EUR 10,000 with 10% interest over 30 years, this would look like this:

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    This can be very important, especially in phases with low interest rates, in order to achieve positive returns over the long term, especially since the compound interest effect also counteracts inflation. Therefore, the earlier you start making a long-term investment, the greater the compound interest effect.

    As Albert Einstein once said, “The compound interest effect is the eighth wonder of the world. Those who understand it earn from it; everyone else pays for it.”