The Magic Of Compounding...

July 27, 2014
Yew Kong Lye

If a Genie or your Fairy God Mother comes along and ask you: “If I give you $1,000,000 now or 1 cent that doubles every day for the next 30 days. What would you take?” What would your answer be? Write it down and read on for I’m about to expose you to one of the greatest concept that I’ve learnt. I will bet that at the end of it you’ll ask: “If it’s that simple, why isn’t everybody doing it?”



When we invest in either shares or property on a long term basis, we are aiming to put a sum of money down today and getting it to grow over the period we are intending to invest. The greater the growth, the more wealth we’ll accumulate. The general idea is to invest our hard earned money in investments that grow at a good rate and hang on to it for as long as we can.


The amount that we invest is called the principal and will generate a certain rate of return per annum for all your troubles and the risk that you have taken. Imagine if you invest $1,000 on the 1st of January in a bank deposit and it pays 10% interest per annum. On 31st December you will earn $100 in interest making a total sum $1,100 available for re-investment. If this amount is reinvested for the next 29 years, earning interest upon interest, what would your principal be? Exactly $17,449.40. Investing just $1,000 and getting 10% per annum interest each year for 30 years. Imagine if you just invested $10,000 at 10% and nothing again, you’ll land up with $174,494.00 after 30 years. Is that a handy nest egg for retirement?



Lessons We’ve Learnt but Never Applied


Wow! How powerful is that? This is not financial advice. This is the principle of compounding at work which we’ve all learnt at school and forgotten or never thought it could apply to our daily lives. When you really get it, it’ll transform your whole concept around investing and how to provide for your retirement.


The older generations especially have been taught a lot of things at school but never important life skills like managing your finances. Many of us leave school without even learning how to balance our bank accounts and we wonder why we spend more than we earn. I suspect the credit card people rely on this fact and do a roaring business by offering ready credit and charging high interest.


An Amazing Exercise


We digress. Let’s get back to understanding the magic of compounding. When well understood, it can provide a break through about how disciplined investment over time can provide a healthy nest egg for retirement.


From the above example, investing $1,000 at 10% return will result in a nest egg of $17,449.40. Now imagine if you invest $1,000 every 1stJanuary for the next 29 years. If you’re 25 to 30 years old now, you'll only be 55 to 60 years at the end of the investment cycle-well before retirement age. The principle works in the same way for real estate, only in many multiples. That does not preclude you from considering real estate because you can leverage when investing in real estate.


Now, are you wondering what you’ll end up with? You can work it out yourselves and it’s not difficult. Work out investing $1,000 at 10% for 30 years and that will be $17,449.40. Next, work out investing $1,000 at 10% for 29 years and that will be $15863 and so on. By saving $1000 each year, at the end of 30 years, you will accumulate $181,943 (Source: ASIC Compound Interest Calculator). Imagine if you saved more, say, $5000 each year. That figure turns into a staggering $9,956,888 and even if you saved $2,500, it would be $4,978,444. That’s a lot of bikkies in anybody’s language.



If it’s so Easy…


Why isn’t everybody doing it? I hear you sceptics are asking. I’ll tell you why. It is much easier to spend $5,000 and have a good time than to save it for a rainy day. It’s not in the human DNA to delay gratification. We are designed to avoid pain and gravitate towards pleasure and most decisions are made on that basis.


Another great reason is that most people lack discipline. They start off with very good intentions and then life gets in the way. It's hard to maintain that saving discipline in the face of mounting pressure of bills or worst still, getting caught in an expensive lifestyle. In the scheme of things, saving $2,500 amounts to only a slab of beer a week for a year. It’s amazing how people can’t forego a slab of beer a week to finish up with $5m for their retirement.



Make That Work for You


“A penny here, and a dollar there, placed at interest, goes on accumulating, and in this way the desired result is attained. It requires some training, perhaps, to accomplish this economy, but when once used to it, you will find there is more satisfaction in rational saving than in irrational spending.”- P. T. Barnum

 "Rainy days mean Jack, until you're drenched because you don't own an umbrella"-YK Lye 


Saving is a habit and needs to be cultivated. We are not born with it but once it becomes a habit and properly invested, it will pay huge dividends. Remember, save and invest consistently and let the magic of compounding work for you. Incidentally, if you have taken the million dollar now, you would have kicked yourself. If you had chosen 1 cent that doubles every day for 30 days, you will land up having a mind boggling $450,000,000. Yes, they have not misread. That’s the magic of compounding working for you. Call 0413 871 888 now and find out how the magic of compounding works in real estate.


Posted in: Financial planning

Contact us today.

Additional Comments? * :