It’s time to understand compound interest in growing your money
I am amazed at the power of compound interest.
Many people, including pensioners, save and invest but never benefit from compound interest because they lack the temperament of being patient in allowing funds to grow undisturbed for long periods of time. It was Nobel Laureate and American economist Eugene Fama who said, “Your money is like a bar of soap, the more you handle it, the less you have.” We are living in a society that has a growing number of people who desire “quick fix” and “get rich quick” schemes and at the same time worry about losing money. It’s a “live for now mentality” that robs the future to satisfy the urges of today. Striking a balance is important in life and we should plan to meet the needs of tomorrow as well as today by having a well-diversified portfolio of assets to meet short-term, medium-term, and long-term goals.
One of my clients, who is now retired, expressed concern for her colleagues who years ago started their investment journey with her to meet their respective retirement goals. However, she is the only one who is reaping the benefit of compound interest. By investing small amounts monthly in a diversified investment account, her retirement funds have grown significantly because she allowed the principle of compounding to work for her. Whereas her colleagues didn’t show the discipline and the resilience to keep investing, she invested through ‘thick and thin’. It was renowned American investor Warren Buffet, now 92, who once advised people who are saving for retirement to “invest through thick and thin – especially through thin”. He started his investment journey at age 11.
At age 30 Warren Buffet was already a millionaire and he became a billionaire while in his 50s. It’s reported that 99 per cent of Warren Buffet’s wealth was created after the age of 50. This doesn’t mean that he became wealthy late in life, instead, it shows the power of compounding. His fortune was built slowly, over decades. It simply means the earlier you embark on your investment journey the greater the compounding of your investment.
Compounding is the reinvesting of earnings. It is earning profit on profits that were already earned and earning interest on interest previously earned. The employment of this principle in investing for the long term will see funds growing exponentially. That’s how wealth is created. Compounding occurs over time and not overnight. If you are starting your investment journey in your 50s or 60s, don’t be daunted. You may be a late starter but success can be yours if your stay the course. Be reminded people are living longer so you may spend 30 or more years in retirement. Do you want to run out of money? Don’t run out of time. Use the time to your advantage.
Let’s look at a client who used time to her advantage.
This client invested $14 million in 2012. But in 2013 the valuation showed that her account had declined to just over $11 million. She stayed the course, though not in a position to make any further deposit. In 2015 her account had grown to $25 million and at the end of 2018 the fund was valued at $69 million. This is an example of compounding. Noted Investor and philanthropist Charles Munger once said: “The first rule of compounding is never to disrupt it unnecessarily”.
The local stock market has been in decline and some investors have grown weary of waiting on recovery. Some people want a prediction of better days, while others continue to invest through thick and thin. They understand the principle of compounding. They believe better days will come and they will be ready to reap the harvest in due course. These investors are accumulating assets. There is no need to worry about short-term values as they seize the opportunity the declining values present by buying more stocks or shares at cheap prices. They have emergency funds in place to take care of unforeseen expenses in the short term.
Investors with a long-term mindset understand that there will be hills and valleys, peaks and troughs, and growth is not a straight line. Real estate and stocks are good assets to invest in for the long term as they are great sources of investment income and will beat inflation. Bonds are an excellent source of predictable income and ideal for short-term goals.
One financial principle expounded by Buffet is: “Do not save what is left after spending but spend from what is left after saving.” It means to make a decision on how much you need to save or invest each month and then spend from the amount that remains. Be reminded that small amounts add up and compound. Buffet said that his life has been “a product of compound interest”. Yours can too. Let’s invest wisely.
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