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In order
to retain the purchasing power of your investment, you need
annual growth that equals the prevailing inflation rate. For
the last 10 years the inflation rate was approximately 3% per
annum. It is reasonable to assume that the next 10 years will
not differ much. On that basis you would need 3% growth just
to stay even. If you invest your money at 10%, which is the
average mutual fund return for the last ten years, you will
barely retain the purchasing power of your money, since you
also have to pay taxes. Most investors are in a tax bracket
exceeding 30%, including federal and state income taxes. Therefore,
if you earn 10%, you are at best making 4% net. Now
let's see what happens if a growth company grows at 30%. First, your
net after taxes is 21%. Your net after the inflation rate
is 18%, which is exactly 4.5 times the net return of 4% you
get from an 10% investment. It is therefore important to find
investments that give you a high return. In the long term,
companies growing at an above average rate will keep making
a decent return on their investment in spite of temporary
setbacks.
To summarize,
30% growth will increase your net 4.5 times faster than 10%.
Therefore, you must go for higher returns and higher multiples.
The assumption that a low multiple stock is a bargain is almost
always wrong.
Take
the time to build yourself an indexed growth portfolio, comprised
of high quality high growth companies. Monitor it, eliminate
the weak positions, and let growth do its thing. You
will be a happy investor.
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