Assets and Liabilities
31 October 2021
Making savings pay off
31 October 2021
When investing, time is a factor of the utmost importance. I personally believe that an investment should have a minimum term of 15 years. Only in the long term can you make the most of the most important mathematical formula in a person's life: compound interest.
"Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays for it." (Albert Einstein)
Compound interest occurs when the interest earned on an investment is reinvested and added to the initial capital, thereby generating further interest.
To better understand the advantage of using compound interest, I will compare two 15-year investments, both of $ 10,000 with an annual return of 5%. The first has a simple rate, the second instead has a compound one.
The person who invested his $ 10,000 at a simple rate of 5% will receive an annuity of $ 500 per year, so at maturity, the total reached will be $ 10,000 + ($ 500 x 15) = $ 17,500.
The person who invested his $ 10,000 at a compound rate of 5% will have $ 20,789.28 after 15 years. For the calculation, you can use an online calculator like this one (https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php). Below, you can see the result.
Thus, compound interest would have generated a net gain that was about 45% higher than that obtained with simple interest. And as the years go by, this difference increases more and more. After 30 years, simple interest will have continued to yield an income of $ 500 per year for a total investment of $ 25,000. Compound interest, on the other hand, will have increased the principal to $ 43,219.42.
Therefore, you can see how important compound interest is to long-term investments, and how fundamental it is to start saving as soon as possible, without procrastinating. Phrases like "yes then I will...", "now I think about it...", "in a few years I will..." have only one purpose, to make you lose money.
This is why I make this appeal so much to young people. Save up, even just $ 50 or $ 100 a month will make all the difference in the world. Initially, it will be little but when you get to my age, you will bless the day you started doing it. Look below to see how much you can earn, even when starting from scratch and paying $ 100 a month for 15 years.
Warren Buffett, one of the richest men in the world with assets of over $90 billion, started saving from the age of 11. I hope this spurs some of you to start saving (if you haven't already). You will learn how to do this in part 2 of this journey.
Another advantage of compound interest is that leaving your gains invested means they will not generate taxes to be paid for as long as they are not cashed (at maturity of the investment). Well, you may say, sooner or later anyway, I have to pay the taxes, what difference does it make? Very true, but by not paying them immediately, you will have more money to add to your capital which is generating more interest and believe me, this is not a small thing.
Compound interest is a great "invention." Alas, it is also used in reverse against you by banks when you apply for a loan or a mortgage. The instalments of a loan, for the first few years, will be composed almost entirely by interest and very little by capital, meaning that the following year, you will find yourself with practically the same amount of debt. This can be ruinous for you, especially if you have taken out a mortgage.
It is important, therefore, to know the potential that compound interest has, and how you can use it to your advantage, whilst being aware of the ways it can be used against you.
I personally believe that an investment should have a minimum term of 15 years. Only in the long term can you make the most of the most important mathematical formula in a person’s life
I am a macroeconomic and financial analyst with over 30 years’ experience, including two years as a fund manager. I specialise in currencies and commodities, and I am the author of several successful books on trading, macroeconomics, and financial markets.
