Cramer: The magic of compounding—how to double your money in 7 years

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The truth about money in the U.S. is that unless you are born with a silver spoon in your mouth, there aren’t many ways to become really wealthy. That is why Jim Cramer is so passionate about helping investors plan for a viable financial strategy.

“Thanks to the magic of compounding, the earlier in your life you start investing in the market, the bigger your long-term gains can be,” the “Mad Money” host said.

Cramer is confident that even if an investor doesn’t have a high-paying job, as long as they save a decent chunk of their paycheck and invest it wisely each year, they can grow their wealth and become at least financially independent.

When Cramer researched the S&P 500 going all the way back to 1928, before the Great Depression, the average annual return through the end of 2014 was about 10 percent, including dividends.

“Show me an asset class with a better average return. You can’t do it! Stocks aren’t just the best game in town, they are really the only game in town if your goal is to grow your wealth,” Cramer said.

The 10 percent average return on the S&P 500 may not seem impressive at first, despite the fact that it’s more than double what one can expect from a 30-year Treasury bond and way more than what a certificate of deposit from a bank pays.

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However, with an understanding of the magic of compounding, it is impressive. For instance, if $100 is invested in the S&P 500 and it gains 10 percent in a year, that will generate $110, after another year it’s $121 and after a third year it’s $133.

The gains will continue to get larger because each year, money is made from the previous year’s profits. With that 10 percent average annual return, one can double their money in about seven years, Cramer said.

“The magic of compounding works best the younger you are, because that means you have more time for your money to grow,” Cramer said.

For instance, if a 22-year-old is just entering the work force they have more than 40 years before they retire. They can invest $10,000 in an S&P index fund right now with the anticipation that the next 40 years won’t be too different from the last 40 years.

In that case, if the average return remained at 10 percent, in 40 years that $10,000 investment will be worth more than $450,000. Making that money didn’t require any stock picking or trading or even research on individual companies.

“All you have to do after you initially save that money is let it sit on the sidelines, ideally in a 401(k) plan or an IRA so that you don’t’ have to pay capital gains or dividend taxes on your gains,” Cramer said.

The same logic can be applied to those in different age groups, but it’s best to start early to get the biggest bang for your buck.

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