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  • Bill Holmes

Things every young person needs to know about money - Chapter 5 – Compounding can be your friend!


Compounding can be your friend or your enemy!

“Enjoy the magic of compounding returns. Even modest investments made in one's early 20s are likely to grow to staggering amounts over the course of an investment lifetime.” John C. Bogle


“The time to save for the future is now. Thanks to compounding interest, the earlier you start putting money away for the future, the more you will save.” Alexa Von Tobel


The definition of “compound”: calculate (interest) on previously accumulated interest.


The impact of compounding will be affected by two other variables: 1) The rate of return 2) how often compounding occurs. The frequency of compounding can vary from once a year to every day, and daily compounding adds the interest accrued at the end of each day so it can earn additional interest the next day, and even more the day after that!


Read that again slowly. Wow!


The rate of return doesn’t need to be tied to an interest rate. If you invest in a security, you can take advantage of compounding by purchasing dividend issuing stocks and using each dividend payment to automatically purchase additional stock. Every payment is greater than the one before, and each payment allows the purchase of even more stock. This creates a virtuous cycle that makes you a little richer each month. If the stock price goes down, you are buying the security on sale and your dividend is even larger!


If you are young, you can harness the amazing power of compounding to your advantage. Here is a famous investing statement that can be found with a simple internet search:


If you started investing at age 25 and put the same amount of money into stocks until age 35, you’d have more money at retirement than if you started saving at 35 and invested the same amount of money in stocks EVERY YEAR until retirement.


Read that again. Slowly. Hypothetically, if you were to invest $5000 a year from 25 to 35, you will end up with more money than investing $5000 a year from 35 to 60? How can that be?


The magic of compounding!


Assuming an 8% return, here are the results. Hat tip to Darwinsfinance.com for the completed table.



Invest early and enjoy the benefits of compounding! Hat tip to Darwinsfinance.com for the chart.

If you are a young person, invest now! Pass on the expensive coffee and systemically invest! Your future you will thank you.


Next I’ll discuss how compounding can be your enemy.


Coda


Does it feel like we are watching two different realities? The reality reported by the mainstream media reflects a country wracked by a new variant of the Corona virus, and that we all need to stay inside and continue to isolate. Then there is the reality I see every time I go out. Shops and restaurants are full, college is in session and public events are taking place. One of my wife’s colleagues and her husband were just diagnosed with COVID-19, but they are both doing fine. I know the pandemic is real, but I also feel like we aren’t being provided facts so we can make rational risk-based decisions. Isn’t that the only reason for a free press?


#financialliteracy #money #investing #leadership