Adding fuel to the fire
The Sterling ReportSunday, May 24, 2020
Is it over yet? I am sure you have found yourself asking that question (repeatedly) as we navigate “the new normal” and continue to practice social distancing in this COVID-19 world we have found ourselves living in.
If you are one of the lucky ones, your income has not been affected and you are only having to contend with the inconvenience of the restrictions. However, there a lot of people who have not been as fortunate. Many employees have suffered pay cuts or been laid off, and business owners have gone out of business or experienced significant decline in their revenues.
Whether you are in the fortunate or unfortunate category we all have one thing in common —we are all preoccupied with surviving. So while you may see and hear all the messages that are all telling you “now is a good time to invest to take advantage of the opportunities while they last”, we either are too distracted, don't have the time, or most importantly don't have the money to do so!
Luckily, if you are not dependent on the interest or dividends from your existing investments and wish you could invest more, there is actually a simple way to accomplish that. Instead of taking the interest payments and spending it, reinvest it. Reinvesting interest or dividends is one of the easiest and cheapest ways to increase your holdings over time.
I know that sounds too simple. But this is where things get interesting (pun intended). When you keep reinvesting your returns from your investment it is like adding fuel to the fire. Your money grows faster because interest is calculated on the accumulated interest over time as well as on your original principal.
So not only are you getting interest on your initial investment, but you are getting interest on top of interest and so the pot of money keeps growing! This is the power of compounding.
Interest is calculated in two ways—simple interest and compound interest. Simple interest is only paid on principal, while compound interest is paid on the principal plus all the interest that has previously been earned — so essentially “interest on interest”.
This is one of the most useful concepts in finance and has been used by many investors to grow their wealth exponentially. For example, if you invested $25,000 at six per cent your investment would be worth $62,500 after 25 years. However, using compound interest, the value would balloon to more than $107,000.
The magic ingredient that makes compound interest work best is time. The simple truth is that when you start investing outweighs how much you start with.
A small investment left untouched for a period of decades can add up to a large sum, even if you never add to the investment.
If you like the sound of this and have been wanting to invest more during the current market lows, an easy way to do that is to instruct your financial institution or broker to automatically reinvest your interest and dividends, and let your money compound for as long as possible. You may be surprised at how quickly this can add up.
Toni-Ann Neita-Elliott, CFP is the AVP Personal Financial Planning at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual, and institutional investor. Visit our website at www.sterling.com.jm
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