Perhaps it comes from deep in our investor psychology - that risk-taking part of us that loves the quick buck. Or maybe it's simply the aesthetic side of us that prefers round numbers - saying you're "up 97%" doesn't quite roll off the tongue like "I doubled my money." Fortunately, doubling your money is both a realistic goal that investors should always be moving toward, as well as something that can lure many people into impulsive investing mistakes. Here we look at the right and wrong way to invest for big returns.
The Classic Way - Earn It Slowly
Investors who have been around for a while will remember the classic Smith Barney commercial from the 1980s, where British actor John Houseman informs viewers in his unmistakable accent that they "make money the old fashioned way - they earn it." When it comes to the most traditional way of doubling your money, that commercial's not too far from reality.
Perhaps the most tested way to double your money over a reasonable amount of time is too invest in a solid, non-speculative portfolio that's diversified between blue-chip stocks and investment grade bonds. While that portfolio won't double in a year, it almost surely will eventually, thanks to the old rule of 72.
The rule of 72 is a famous shortcut for calculating how long it will take for an investment to double if its growth compounds on itself. According to the rule of 72, you divide your expected annual rate of return into 72, and that tells you how many years it takes you to double your money.
Considering that large, blue-chip stocks have returned roughly 10% over the last 100 years and investment grade bonds have returned roughly 6%, a portfolio that is divided evenly between the two should return about 8%. Dividing that expected return (8%) into 72 gives a portfolio that should double every nine years. That's not too shabby when you consider that it will quadruple after 18 years.
The Contrarian Way - Blood in the Streets
Even straight-laced, even-keeled investors know that there comes a time when you must buy - not because everyone is getting in on a good thing, but because everyone is getting out. Just like great athletes go through slumps when many fans turn their backs, the stock prices of otherwise great companies occasionally go through slumps because fickle investors head for the hills.
As Baron Rothschild (and Sir John Templeton) once said, smart investors "buy when there is blood in the streets, even if the blood is their own." Of course, these famous financiers weren't arguing that you buy garbage. Rather, they are arguing that there are times when good investments become oversold, which presents a buying opportunity for brave investors who have done their homework.
The Safe Way
Just like how the fast lane and the slow lane on the freeway eventually lead to the same place, there are both quick and slow ways to double your money. So for those investors who are afraid of wrapping their portfolio around a telephone pole, bonds may provide a significantly less precarious journey to the same destination.
But investors taking less risk by using bonds don't have to give up their dreams of one day proudly bragging about doubling their money. In fact, zero-coupon bonds (including classic U.S. savings bonds) can keep you in the "double your money" discussion.
For the uninitiated, zero-coupon bonds may sound intimidating. In reality, they're surprisingly simple to understand. Instead of purchasing a bond that rewards you with a regular interest payment, you buy a bond at a discount to its eventual maturity amount. For example, instead of paying $1,000 for a $1,000 bond that pays 5% per year, an investor might buy that same $1,000 for $500. As it moves closer and closer to maturity, its value slowly climbs until the bondholder is eventually repaid the face amount.
One hidden benefit that many zero-coupon bondholders love is the absence of reinvestment risk. With standard coupon bonds, there's the ongoing challenge of reinvesting the interest payments when they're received. With zero coupon bonds, which simply grow toward maturity, there's no hassle of trying to invest smaller interest rate payments or risk of falling interest rates.
The Speculative Way
While slow and steady might work for some investors, others may find themselves falling asleep at the wheel. They crave more excitement in their portfolios and are willing to take bigger risks to earn bigger payoffs. For these folks, the fastest ways to super-size the nest egg may be the use of options, margin or penny stocks.
Stock options, such as simple puts and calls, can be used to speculate on any company's stock. For many investors, especially those who have their finger on the pulse of a specific industry, options can turbo-charge their portfolio's performance. Considering that each stock option potentially represents 100 shares of stock, a company's price might only need to increase a small percentage for an investor to hit one out of the park. Be careful and be sure to do your homework; options can take away wealth just as quickly as they create it.
For those who want don't want to learn the ins and outs of options but do want to leverage their faith (or doubt) about a certain stock, there's the option of buying on margin or selling a stock short. Both of these methods allow investors to essentially borrow money from a brokerage house to buy or sell more shares than they actually have, which in turn can raise their potential profits substantially. This method is not for the faint-hearted because margin calls can back your available cash into a corner, and short-selling can theoretically generate infinite losses.
Lastly, extreme bargain hunting can quickly turn your pennies into dollars. Whether you decide to roll the dice on the numerous former blue-chip companies that are now selling for less than a dollar, or you sink a few thousand dollars into the next big thing, penny stocks can double your money in a single trading day. Just remember, whether a company is selling for a dollar or a few pennies, its price reflects the fact that other investors don't see any value in paying more.
The Best Way to Double Your Money
While it's not nearly as fun as watching your favorite stock on the evening news, the undisputed heavyweight champ of doubling your money is that matching contribution you receive in your employer's retirement plan. It's not sexy and it won't wow the neighbors at your next block party, but getting an automatic 50 cents for every dollar you deposit is tough to beat.
If It's Too Good to Be True …
There's an old saying that if "something is too good to be true, then it probably is." That's sage advice when it comes to doubling your money, considering that there are probably far more investment scams out there than sure things. While there certainly are other ways to approach doubling your money than the ones mentioned so far, always be suspicious when you're promised results. Whether it's your broker, your brother-in-law or a late-night infomercial, take the time to make sure that someone is not using you to double their money.
Read more: http://www.investopedia.com/articles/stocks/09/five-ways-double-investment.asp#ixzz1zqgLhswP
The information contained in this article does not constitute a recommendation, solicitation, or offer by D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.
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