COMPOUNDING occurs when interest or income earned on investments is reinvested, thereby making the initial principal or investment bigger and resulting in funds growing faster than simple interest.

Are you earning simple interest on your principal or are your investments benefiting from compound interest? Albert Einstein, commenting on compound interest, said, “He who understands it, earns it; he who doesn’t, pays it”. Compound interest works for you by increasing the value of your investments and it works against you by increasing the size of your debt, such as outstanding loans and credit card balances.

Managed funds or pooled funds are excellent investment options for compounding investments as dividends and profits are reinvested, thus creating greater returns on the investments. If regular deposits are made to the investments, the compounding will be much greater and funds will grow much faster over the long term. To maximise the benefits of compounding it is best to start investing early. Have a goal for your investment. Be disciplined and be patient. It pays to know the reason you want to invest your money so you can keep on track. Regardless of the size of one’s income, investing regularly from one’s income requires discipline. Investing early gives funds more time to grow as time and compound interest are a powerful combination for financial freedom and wealth creation. It’s important to note that, in saving early for retirement, most of the retirement funds will come from the interest earned from compounding rather than the money saved or invested during the working years. Compounding maximises time and minimises risks. Long-term investments yield the most success from compounding.

A retiree’s story

At BPM Financial an 81-year-old client and pensioner told a remarkable story of investing long term and reaping the benefits of compound interest while minimising risks. In 2008 she invested $500,000 in a Jamaican-dollar bond and $500,000 in the Local Equity Portfolio at BPM Financial Limited. Her investments were made amid the global subprime mortgage crisis when stock markets were down globally. That year the Local Equity Portfolio at BPM Financial declined by just over 14 per cent. This account took three years to recover the loss. In 2012 she withdrew $300,000 and made another withdrawal of $1 million from her Equity Portfolio account in 2017. The balance in her account in January 2020 was over $10 million. She did not make any additional deposits since opening both accounts. This scenario demonstrates the power of compounding. Within 12 years of investing her principal of $500,000 investment had multiplied 20 times. It proves that investment in the stock market should be a long-term goal and not viewed as an overnight get-rich-quick scheme.

An important lesson the retiree learnt was how to be disciplined, persistent, and patient during times of market volatility. Her Equity Portfolio Investment has experienced three major stock market crises in 14 years but has provided a buffer to withstand the economic shocks. With the advent of the novel coronavirus pandemic, her Equity Portfolio declined to less than $7 million in 2020. She weathered the financial storm. A slow recovery saw her equity account at just over $7 million in 2022 as the war in the Ukraine sent stock markets reeling globally. Unphased, this retiree was able to withdraw $2 million from her equity account during the crisis.

Investing in a managed equity fund has proven to provide financial resources to meet her needs as she pointed out that she withdrew her principal years ago, and still is benefiting from what is termed her “money-making machine” at BPM Financial Ltd. In the meantime, her bond portfolio has multiplied four times in 14 years. This retiree has a diversified investment strategy. Her Equity account, which is high risk, has multiplied far more times than the low-risk bond portfolio. At 81 years of age, this client lives comfortably in retirement as her behaviour toward investing for the long term has yielded substantial returns for her. The importance of having a qualified and experienced financial advisor, as well as investing in the right systems to grow her investments were underscored. She was determined to save for her retirement and to invest wisely during the retirement years. As she puts it, “I don’t want to rely on my children.” She felt it was her responsibility to plan for her future, but it required sacrifice and investing wisely, ensuring multiple streams of income. As author Brian Tracy says, “Most great fortunes are built slowly.”

Grace G McLean is financial advisor at BPM Financial Limited. Contact her at gmclean@bpmfinancial and visit the website: www.bpmfinancial.com. She is also a podcaster for Living Above Self. E-mail her at livingaboveself@gmail.com