Compound interest may yield the most

Never forget the investment industry favours strategies that bring it the fattest fees. Conversely, always remember the power of compounding interest.

Solid ways to invest for profit certainly exist. However, these tend not to be so profitable for the ‘middle men', that is the brokers. As such, they are rarely promoted by the industry.

Conversely, you will see plenty of encouragement to chop and change your investments by moving from one hot area to another — huge returns are possible. Not surprisingly, buying and selling investments quickly makes the industry a lot of money. The practice costs individual investors dearly, however.

With stock charts, we can see big risers and big fallers in the stock market every day — if only we could catch them before the move, we could get rich fast. Sadly, it's hard to find anyone that manages this. Plenty of people have wasted a lot of hard-earned cash chasing the dream.

Basic theory states the market experiences a percentage growth factor over the long term. This is often said to be 7 per cent per year on average. So if you bought and sold once a year, with fees costing 1 per cent, you would on average make 6 per cent a year.

Costs hurt

To make more, you have to be a smarter stock picker. The smartest on record is the American Warren Buffett. In the long term, his profits have been about 25 per cent a year. You can consider that as good as it gets. Therefore, if you trade once a year and it costs you 1 per cent, you can potentially get returns of 6-24 per cent a year.

If you buy and sell like a maniac you will rack up costs. Even with just 0.25 per cent costs, if you turned your portfolio over every week you'd easily burn through 12.5 per cent of it in a year. That would mean you would have to make a 12.5 per cent profit just to stay even. Meanwhile, your broker will love you!

If you had been smart and invested only once that year, you would be sitting on a fat 11 per cent profit rather than nothing at all. However, your broker would think you a poor customer as he made very little from you.

The trouble is; catching more than the growth of the market is very tricky. When you look at the data, there is nothing short term that you can reliably jump on to get more than a day's worth of the average yearly return coming to the market — if you could split the good days from the bad days, you could make a fortune.

Random

Sadly you can't — all the investment banks and hedge funds in the world have already trawled through the data and exploited all these kinds of market kinks until they have been hammered out. This makes the market random from hour to hour, day to day, so no stock chart or rule of thumb gives you advance warning of a big move. By all means look for them, but once you have, you should spend a few dozen hours researching it. You will see there is no "magic" trading formula.

This means you are left with boring old investing. Yet investing is how wealth is built. It's the way the boring old guy who gets 25 per cent a year became the richest man in the world. How? Through what Einstein allegedly called the greatest invention ever: compounding interest.

The writer is CEO of financial information site ADVFN.com and author of titles including ‘101 Ways to Pick Stock Market Winners'.