Snowball effect or investment strategy is an analogy for wealth compounding. It implies multiplying your wealth and income many times over using DRIPs (Dividend Reinvestment Plans). To understand the term simply, when you pitch a snowball from a mountain top, it starts to get bigger by picking up more snow, and consequently making it a giant ball. It signifies your small action can take bigger consequences over time.
What is a Snowball Investment Strategy?
A snowball compounding refers to the investment on high-quality dividend growth stocks over time, which can produce bigger amounts. Once your dividend becomes higher, you can reinvest it to give a powerful effect.
Usually, snowball-compounding effects are much higher than other relatively lower investments. So, you can expect to reach your goals timely and efficiently. In Spite of that, you can’t expect that you’ll become a millionaire over some years of investments. Like any other investments, it also takes your time, patience, and strategies to build a strong portfolio and give results.
How Does It Work?
To understand the snowball effect, you need to have a good grasp of compounding.
For example, imagine you’re starting with an investment of 1000 rupees in low-cost index funds. It tracks the performance of a broader market index fund like the S & P 500.
The next year, your investment is worth 1,100 rupees by 10% returns from the index funds. Now, instead of cashing out the money, you decide to reinvest additional 10/ rupees making it even bigger for the next share in the index fund. So, now your total investment is worth 1,200 rupees. Next year, the index fund returns 8%, so your investment is now worth 1,296 rupees. Instead of cashing out it, you reinvest 96 rupees in additional shares of the index funds. This process continues year after year, with your investment growing larger and larger as you reinvest your profits. Over time, the power of compounding helps you grow exponentially in the investment world.
It works best when you have. A long-term horizon and are willing to be patient without being tempted to cash out. Cashing out the money when the market is doing well can undermine your snowball effect and limit your long-term growth potential.
Benefits
The snowball effect has several benefits to investor, which are as follows:-
- Lower Risk: – Investing small amounts of money over time through snowball effect, it can help reduce your overall risks in investment. When you are putting all your money into one market at once, instead of spreading, it can essentially mitigate your risks.
- Build long-term Wealth: – The snowball strategy is a long-term investment approach, which means that it is designed to help investors build wealth over time. By reinvesting profits, you are allowing your investments to grow exponentially, which can lead to significant wealth accumulation over time.
- Advantages of Compound Interest: – The snowball strategy allows investors to take advantage of the power of compounding interest. This means that as your investment grows, your profit will accelerate over time, which can lead to increased wealth.
- Avoiding Market Timing: – You can have the benefits to avoid market timing through snowball strategy. Instead of trying to market, which can be difficult and risky, you can use a snowball strategy to invest small amounts on a regular basis.
- Automated Contribution: – When you adopt a snowball strategy, you can automatically get the convenience and hassle-free way of investment. You can set the automatic contribution to your investment account, and ensure consistent investment, without having to manually transfer money into your account.
Examples
An investor wants to diversify their portfolio with real estate investments. They start with an initial investment of $10,000 in a real estate investment trust (REIT). They commit to investing an additional $1,000 a quarter. Assuming an average return of 10% after 20 years, their investments would be worth $200,000.
Colgate-Palmolive has been a big brand since 1893. In 1992, it decided to streak consecutive investments on dividend stocks.
Now, with annual compound returns of 32 years, it will be $22.8 million by 2024.
These are some examples where investors can take the advantage of compound interest and achieve significant growth over the long-term.
The Bottom Line
Snowball Investment Strategy is a simple, yet effective investment strategy for investors. If the investor is eligible to make a small investment over a long amount of time, they can incentivize their wealth over time. By adding equal or additional amounts over time, you can harness the power of compounding and watch your investments grow and avoid any types of risks.
