Einstein once said that “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.” While this quote might seem like a bit of an exaggeration, the math behind it begs to differ. Anyone who has been investing for a long time knows that success in the financial world goes beyond just being a good investor. Being patient enough to allow your investments to compound is an equal part of the equation. This week’s article is focused on helping everyday investors gain a deeper understanding of how compound interest really works and how it can help you live a comfortable retirement.
When people think about the greatest investor of all time, the first name that comes to mind is usually Warren Buffet. However, when we look at average annual returns, James Simmons, head of the Hedge Fund Renaissance technologies has been able to compound money at 66% annually since 1988 and no one comes close to this record. Buffet on the other hand has been able to compound roughly 22% annually, which is a third as much.
The only reason Buffet has accumulated significantly more wealth is that Simons did not find his investment stride until he was 50 years old, which is less than half as many years to compound as Buffett. If James Simmons had earned his 66% annual returns for the 70 year span in which Buffet built his wealth, he would be worth sixty-three quintillion nine hundred quadrillion seven hundred eighty-one trillion seven hundred eighty billion seven hundred forty-eight million one hundred sixty thousand dollars. This is obviously a ridiculous amount, but it certainly adds perspective to the power of compounding and what starting early can do for your long-term returns.
Another simple way we try to help our clients understand the power of compounding is by asking them what would happen if they were given a penny and asked to double it every day for the next 30 days. The chart below outlines the growth of that penny after each consecutive day.
It’s crazy to think that by doubling a penny for 30 consecutive days, you could find yourself with a fortune of a lifetime. The simple fact is that when left untampered with, compounding can be a beautiful tool that helps you reach your financial goals. What may seem like small changes in growth can lead to ridiculous amounts of wealth when left to compound over a significant amount of time. As human beings, thinking linearly (8+8+8+8+8+8+8+8+8 = 72) comes easily. Whereas trying to wrap our minds around exponential growth (8x8x8x8x8x8x8x8x8 = 134,217,728) can be quite a daunting task.
Because of its counterintuitive nature, even the smartest of investors ignore the power of compounding and rely on solving problems through other means such as frequently trading in and out of securities. With that being said, you can’t blame people for wanting to quickly cash out from a loss or lock in their gains. It is in our nature to be reactive as opposed to being inactive. However, when it comes to growing wealth in the financial markets keeping your investments boring and untampered with is usually the best outcome for success.
To drive our point home, it would be worthwhile to give a quick case study on why it pays to start investing early.
While oftentimes, individuals don’t think they have enough capital to start investing, the laws of compounding tell us that time is our biggest asset. In the illustration above, we see how starting to invest early can go a long way in helping you secure your dream retirement.
If you want to easily accumulate wealth and take advantage of the magic of compound interest, it’s important to start early and be consistent. The key is to start now and contribute what you can! It may seem like it’s not worth it, but even small contributions of $25-$100 per month add up over time.
Time is your best friend and the one thing that makes compound interest so effective. Saving now and starting early will pay dividends in your future and help you accumulate extra money. That’s the power of compound interest and why it pays to start saving now.
- Kondwelani Kalinda, Licensed Assistant
Kondwelani Kalinda is a Licensed Assistant at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Kondwelani Kalinda who is a Licensed Assistant for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.
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