What is the return-on-return effect?

Investing is one of the most powerful ways to build wealth. And let's be honest, who wouldn't want their money to do the hard work for them? An important concept that comes into play here is the return-on-return effect. This effect is essentially a kind of financial snowball that grows bigger and bigger the longer it rolls down the hill. In this article, we will delve deeper into what the return-on-return effect is exactly, how it works, and how you can optimally use it to grow your wealth. So, buckle up, we're heading towards your financial mountaintop!

What is the return-on-return effect?

The return-on-return effect, also known as the compound interest effect, is the phenomenon where you not only achieve returns on your initial investment, but also on the returns you have previously generated. It's a bit like getting interest on interest, and that interest gets interest again... And so it goes on. Simply put: it is a financial version of "one apple saved for a rainy day ultimately yields an entire fruit basket". Let that fruit basket come!

For example, imagine you invest €1,000 and achieve an annual return of 6%. After the first year, you have earned €60, making your total amount €1,060. In the second year, you get a 6% return on €1,060, which amounts to €63.60. That might seem small, but in the long term, this effect can take on gigantic proportions, just like you simply can't resist “just one more cookie”.

What is the effect of long-term investing?

The return-on-return effect works best when you invest over a long period. This is because time is a critical factor in maximising returns. In the first years of investing, the return is like a young sapling that grows slowly. But as the years pass, that sapling grows into a mighty oak, offering you shade (and perhaps some extra acorns) in your old age.

Suppose you invest €1,000 per year for 30 years with a return of 6%. In the first 10 years, your total return will be modest, but after 30 years, you will see exponential growth. This comes about because you not only achieve a return on your original investment but also on all the returns you earned in the preceding years. As a result, your wealth grows much faster in the later years than in the initial years, a bit like your favourite series that only gets really exciting after season 2.

How does the return-on-return effect help build wealth?

The return-on-return effect is one of the most powerful ways to build wealth because it ensures that your money multiplies itself. It's like your money is hosting a party and constantly inviting more friends, and best of all: all you have to do is enjoy the fun (or in this case, your growing wealth).

If, for example, you decide to leave your investments for 30 years, your wealth will be many times greater than if you were to leave the same amount for only 10 years. The power of the return-on-return effect lies in time. The longer you have to invest, the more you benefit from this effect. A bit like a well-aged wine, it only gets better with time.

An example of this effect can be seen in the table here below: 

What is the best strategy to optimally use the return-on-return effect?

To make optimal use of the return-on-return effect, there are a few strategies you can follow:

1. Start early: The sooner you start investing, the longer you can benefit from the return-on-return effect. Even small amounts can lead to great results over a long period. Think of that one plant you planted as a seed and which is now taking over your whole balcony. You want that for your money too!
2. Invest regularly: Periodic investing helps spread risks and ensures that you continuously benefit from the return-on-return effect. It's just like with exercise: consistency is key (and it’s good for your finances too!).
3. Persevere: Patience is essential. It can be tempting to withdraw your investments during a market downturn, but by persevering and letting your investments grow, you will ultimately benefit more. Because let’s face it, even that dramatic cliffhanger in your favourite show had a great payoff, didn’t it?
4. Reinvest your returns: Make sure your returns are reinvested so that they become part of the total amount that generates returns. It's a bit like a snowball that gets bigger and bigger: it starts small, but before you know it, you have a snowman!

How does periodic investing work?

Periodic investing means that you invest a fixed amount on a regular basis, for example monthly or annually. This has several advantages:

• Risk diversification: By investing regularly, you spread the risk across different market moments, which can help absorb fluctuations in the market. Just like wearing a rain jacket during a hike: you are prepared for unexpected showers.
• Easier to plan: Automatically investing a fixed amount helps maintain discipline and ensures you don't forget to invest. That way, you don't have to worry, just like you never forget your morning coffee.
• Maximum benefit from return-on-return: Every new investment contributes to the total amount that qualifies for the return-on-return effect, which can lead to significant wealth in the long term. It's a bit like that one Netflix marathon: the more you watch, the better it gets!

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The return-on-return effect is a powerful tool for anyone serious about building wealth. By starting early, investing regularly, being patient, and reinvesting your returns, you can optimally benefit from this effect. Investing is not only about the amount of the investment but mainly about the time you allow your investments to grow. The longer you take, the more you can benefit from the return-on-return effect. And remember, just like a good wine, your investment gets better with time!