Snowball Effect

Following on from my last post about leveraging your savings or equity, I am going to demonstrate the Snowball Effect, where the growth of an investment property is allowed to compound year after year.

Compound Growth simply occurs when the growth of your asset from one year is added to the previous balance and the combined larger asset value is exposed to further growth the following year, and so on.

If we use the two growth examples from my last post:

Example 1 – If you had $100,000 in either cash savings (or accessible equity within a property), achieving a yearly return of 5% interest (or capital growth), the balance of this amount would increase by $5,000 in one year.

Example 2 – Instead, if you leveraged the $100,000 as a 20% deposit on an investment property worth $500,000 with the remaining $400,000 borrowed from the bank, and assuming the same 5% annual return as above, the capital growth on $500,000 would be $25,000 in one year.

We can then look beyond the first year and see what happens over the long term when the annual return is compounded year after year:

 Example 1SavingsExample 2Property
Total Growth$107,893$539,464
5% ReturnBalance5% ReturnValue
Start$100,000$500,000
Year 1$5,000$105,000$25,000$525,000
Year 2$5,250$110,250$26,250$551,250
Year 3$5,513$115,763$27,563$578,813
Year 4$5,788$121,551$28,941$607,753
Year 5$6,078$127,628$30,388$638,141
Year 6$6,381$134,010$31,907$670,048
Year 7$6,700$140,710$33,502$703,550
Year 8$7,036$147,746$35,178$738,728
Year 9$7,387$155,133$36,936$775,664
Year 10$7,757$162,889$38,783$814,447
Year 11$8,144$171,034$40,722$855,170
Year 12$8,552$179,586$42,758$897,928
Year 13$8,979$188,565$44,896$942,825
Year 14$9,428$197,993$47,141$989,966
Year 15$9,900$207,893$49,498$1,039,464

When comparing the growth of the two examples you can see the real power of leverage in Example 2. The growth over 15 years on $100,000 in savings is $107,893, but the growth on $100,000 leveraged into property is a massive $539,464! You can see the ongoing annual return increases every year to nearly double in 15 years, this is the Snowball Effect at work!  What’s more important is that because your investment grows faster every year, the end of year balance more than doubles in 15 years!

Plotting this on a chart clearly shows how powerful investing in property can be, when used as a long term wealth creation strategy:

Compound Growth

Saving your money in a bank is better than doing nothing, but you cannot save your way to financial freedom. By using Leverage and Compound Growth together you can really Snowball your savings to create long term wealth.

So what is financial freedom? I discuss what this means in my next post here.