There is nothing better than a big win on the stock market to improve your mood and your finances. Very often it can be tempting to withdraw all or part of your profit at the end of the year to do something special like a holiday, buy a property, etc. However, have you ever sat back and thought about the impact which accumulated profit can have on your investment pool?
Investing £1,000,000 over five years
If we take for example an investment pool of £1,000,000 which is invested over five years with an annual increase of 10%. Whether or not this return is practical is a different matter but for illustration purposes it shows perfectly the value of accumulated profit.
Withdrawing your profit each year
If we take a scenario where an investor withdraws all of their profit at the end of each year this will give you an idea of the power of accumulated profit. £1,000,000 invested over five years with an annual increase of 10% would see your investment pool maintained at £1,000,000 but £500,000 in profit taken from the fund. This is by no means a nightmare scenario because you have withdrawn £500,000 and retained the value of your portfolio. However, the situation is very different if you are able to retain all of your cumulative profit for the full five years.
Accumulating your profit within your investment pool
If we look at a similar scenario, investing £1,000,000 over five years with a 10% annual increase, with no profit withdrawn, the situation is very different. After the five years you would have investment pool of £1,610,510 which would be a gain of £610,510. The beauty of this strategy is that the funds which are retained within your investment pool also increase annually which is why, after taking into account the £500,000 withdrawn over five years in the above illustration, you are £110,510 up using the accumulated profit strategy.
It is also worth noting that where you remove the annual profit each year your investment pool may stay at £1 million but due to inflation your buying power is reduced each year.
Investment pool
Professional advisers will always say to you that any funds invested in long-term markets should be funds that you will not require in the short to medium term. There will no doubt be occasions where you may require additional funds for a variety of reasons which were unforeseen, but in theory anything you invest in the stock market should be seen as a long-term play. The chances are that if you did need to withdraw all or part of your funds at short notice the markets would be struggling and share prices would be down. Isn’t that the way it always works?
The basic lessons to learn from accumulated profits, retained in your investment pool, is that not only will the retained profit increase in line with your portfolio but additional funds also give you the opportunity to diversify your investments. Diversification is a subject we have covered on numerous occasions and one which is well worth revisiting if you have the time.