Compound interest, time, and your money
IT is important for investors to understand how compound interest and time impact your money.
I find that some employees, self-employed persons, and retirees don’t see themselves as investors. The ones who do have a better appreciation for compound interest and time are, therefore, ahead of the investment game. I am, however, encouraging employees to become investors.
Let’s look at the differences between an employee, a self-employed person, a business person, and an investor. An employee has a job and works for money and a self-employed person owns a job and also works for money. The businessman or business owner builds or owns a business or system that employs persons to work for them, whereas investors put money to work and their money keeps making more money. Investors work at converting money to wealth through compound interest and time. However, while we may find ourselves working for money, we should endeavour to put some of that money to work for us so that someday in the future when we stop working, our money will continue to work. In this way, we have more freedom to do what we love and enjoy peace of mind. Always remember that your money should never go on retirement.
Be reminded that compound interest allows your money to earn interest on interest that was already earned as well as interest on the principal. The longer you have your money working, the more interest you will earn and your pool of money gets bigger with time. If interest on your investment is earned monthly, this means that every month you will be earning more interest on the money that you invested as you keep earning interest on the previous interest that was earned. Please note that you will not earn compound interest on a regular savings account. Also, be mindful of fees as these can erode interest earned on your investment. Remember the longer your investment is undisturbed, the more work your money will do for you. This is the reason we need to take a long-term view on investments. Frequent withdrawals are an enemy of compound interest and investments. Withdraw funds when needed and not because you can. Your money needs time to work on your behalf.
Last week, I spoke with a client who started an investment account in 2007. At the time her employer didn’t have a group pension in place and approved personal pension plans were not yet available. This client along with other co-workers decided to start individual investment plans for their retirement. She saved $6,000 per month and now 16 years later she is on early retirement at age 60 and has benefited from compound interest working for her to provide income for the future. An interesting observation made by her was the fact that some of her colleagues were not as disciplined, and during times of accelerated growth of their investments they withdrew funds either too early or too frequently from their investments. The account that was opened for this client consists of stocks and bonds. The average growth rate on this account was 11 per cent per year and this average includes the periods of drastic decline in the stock market during the pandemic period and in 2022 when stock markets globally experienced turbulence. Experiencing a growth average of 11 per cent per annum, according to the Rule of 72 financial formula, (which calculates how long your investment takes to double in value), her investment is expected to double every seven years. She therefore should not panic even though the local stock market is declining as compound interest and time continue to work in her favour. If she continues to add small amounts to her investment during the stock market decline, she will benefit from purchasing more shares of growth or blue chip companies at low prices, and when the market recovers there will be far more shares working for her. This means the shares will make more money on her behalf. When dividends are reinvested it means more shares are purchased to create more money and the compounding effect will result in exponential growth of her investments.
Even though her account was opened in 2007, she didn’t make a withdrawal until 2017 (that’s 10 years later). This client is an investor. An analysis of her account showed that she has already withdrawn the principal amount invested. She had a long-term horizon for her investment and kept her eye on her retirement goal throughout the 16 years of investing. Her investment is poised for rapid growth. The balance in her account is still more than the amount that she invested despite withdrawing all the funds invested. This is how compound interest and time work together to meet your financial goals. For the best returns on investments acquire assets that will increase or appreciate with time, such as stocks and real estate. Legendary investor Warren Buffet said, “price is what you pay, value is what you get”. Be an investor!
– Grace G McLean is a financial advisor and retirement specialist at BPM Financial Limited. Contact her at: gmclean@bpmfinancial, or visit the website: www.bpmfinancial.com. She is also a podcaster for Living Above Self. E-mail her at firstname.lastname@example.org