Compound interest

Compound interest rewards patience in an impatient world

Compound interest – its impact is truly miraculous. I have been writing and talking about its power for over 30 years, but do you understand?

The start is slow: not much happens in the first few years. But that’s life – anything worth it takes time. This applies to getting into shape, losing weight, improving your sport, or starting a business.

Accept that success takes time

In his book Atomic habits, James Clear speaks of “the plateau of latent potential”. He likens the plateau to a species of bamboo, which spends its first five years building vast root systems underground, before shooting 90 feet into the air in six weeks. Just because it sometimes takes longer that we would like to see the results of our efforts does not mean that our efforts will be in vain.

In fact, most of the important work – the build-up – won’t seem like it comes down to anything, but of course it does.

Any goal that we have will take time and effort to achieve and starting it will likely be more difficult than finishing it. But we have to keep going, because habits and hard work add up.

Epictetus tells the story of Lampis, the shipowner, who, when asked how he acquired his great wealth, replied: “My great wealth was acquired without difficulty, but my little wealth, my first gains, with much of work ”. Yet the average human being is wired for quick results. This is why many who start an investment program (or fitness program, change in diet, sport or business) give up very early. They are discouraged by what they see as a lack of progress.

Just be patient and consistent

So in the composition you have to wait to see the results. Your small, consistent efforts, if you are patient and consistent, will reap great rewards. But the other most important factor that determines how quickly your money will grow is the rate of return you get. The combination of time and a good rate of return turns small amounts into a small fortune.

Over Christmas, I was delighted to receive an email from a woman I first met as a customer in 1991, 30 years ago. Beryl is now 88 years old and the $ 20,000 I invested for her in January 1991 in the imputation fund is now worth just over $ 700,000. The fund was managed by legendary investor Robert Maple-Brown until his death in 2012.

The numbers are fascinating. If we look at the stock market calculator on my website, we find that $ 20,000 invested in the Regular Accumulation Index in January 1991 would now be worth $ 337,000. That’s a 10.23% return per year, which is great compared to anyone. However, Beryl’s fund clearly beat the index. If we run the numbers using my compound interest calculator, we find that a 12.6% per annum return would go from $ 20,000 to $ 700,000 in 30 years. This 2.37% difference in rate of return has nearly doubled Beryl’s money over the past 30 years.

Why did I compare its returns to the All Ordinaries Index? Because the index is accessible to all investors, whatever their financial knowledge, and it is not necessary to choose the winners. About 20% of actively managed funds outperform the index over the long term. The Catch-22 is that 80% does not beat the index after the charge is factored in.

So the problem for investors is to find the best performing funds. The obvious solution is to consult a good advisor for advice on funds that suit both your goals and your risk profile. Good advice costs upfront, but in the long run it costs nothing – it pays off.

But financial success isn’t just about choosing the right selection of managed funds. Beryl’s husband is now 94 and they have a large sum of money coming out of an account maturing and bearing interest in about a month. She also wanted to give me my opinion on what to do with the maturing money.

Financial planning options

After a long discussion, I pointed out that at their stage of life, ease of management is paramount. Since their investments are already well diversified for their age and they have no chance of getting the old age pension, they could just leave the stock trust to continue to compose and dip into the money in the bank. Hopefully, confidence in stocks will increase faster than their money in the bank decreases. They might also consider donating funds to family members as soon as possible, updating their wills, and / or increasing donations to charity.

Beryl then revealed that they have eight grandchildren at different stages of their lives. Some are good fund managers, and some are on the other end of the spectrum. This caused them serious concern.

This is where further advice is essential. There will be a significant unrealized gain on the shares, which could be mitigated if their wills are written so that the funds under management go to the grandchildren who intend to keep the funds intact. Testamentary trusts are also an option.

I recommended that Beryl and her husband speak to a lawyer specializing in estate planning, and involve both their accountant and a financial advisor, to draft their wills in a manner that is both tax efficient and fair.

Thanks to compound interest, this couple face one of the best problems any investor can face – how to best use it and give a lot of money. I concluded our phone conversation by reminding her of the Chinese proverb: “The best cashews come when the teeth are too old to chew.”

Noel Whittaker is the author of Making Money Made Simple and many other books on personal finance. [email protected] This article is for general information and does not take into account the situation of any investor.