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According to Einstein (who should know a thing or two) The Eighth Wonder of the World is compound interest. “He who understands it earns it… he who doesn’t… pays it.”
Quick question - Do you want a $1,000,000 immediately, or a magic cent that doubles in value every day for a month?
(Hint - At the end of the month, your magic 1 cent coin is now worth over $5,000,000.)
An even more impressive example is the fable about the Pilgrim who played the chess-obsessed Indian King and won. The prize was a grain of rice in the first square of the chess board, two grains in the next squares, four grains in the next, and so on - for 64 squares.
The 64th square apparently has enough rice to cover all of India in a metre deep layer of rice.
So, what’s the point of magic coins and overflowing rice? The principle of compounding wealth.
Compounding is one of the fundamental components of wealth creation and is nothing new to fund managers, stockbrokers or financial advisers.
Compounding is a self-fulfilling cycle, where your investment earns interest, and then your interest earns interest, creating a snowball effect (not as impressive as the rice example but the principal is the same.)
With simple interest, you only generate interest of the money you originally invested. With compound interest, you'll earn money on the money you invest plus you'll earn interest on the interest you earn.
Some examples of investments that include compounding interest include:
• Real estate
• Rental property
• Stocks
• Savings
• Managed funds
• Bonds
• Retirement funds such as KiwiSaver
• And so forth.
One of the key things to compounding your investments is starting early, because time is a critical element in this.
If you are consistent with your deposits, the longer you have, then the more you will have. With the coin example, day 21 is a little over $10,000, but Day 30 is over $5,000,000.
Now your investment isn’t going to double every day, week, or year most likely - but the principal is the same. So - start early, be consistent, and the magic will happen.
Compounding wealth is our jam. It costs nothing to float your ideas past us and get informed about your choices. You may be surprised where your little snowball could end up. Give us a call.
One last thing that isn’t a fable, is a very helpful formula when looking at investments with compounding interest.
“The Rule of 72” is a formula that I use regularly to calculate how long my initial investment will take to double in value with a prescribed compounding interest rate.
Often it gets used with house prices. For example, if house prices are increasing at 6% a year, how long will it take for my House to double in value?
Well 72/6=12 … So in 12 years’ time, my house will have doubled in value.
If the rate of increase is 3% then its 72/3= 24 years.
And last thing last thing, these are the seven ancient wonders of the world just in case you were concerned about that are
• Great Pyramid of Giza, Egypt.
• Hanging Gardens of Babylon.
• Statue of Zeus at Olympia.
• Temple of Artemis at Ephesus.
• Mausoleum at Halicarnassus.
• Colossus of Rhodes.
• Lighthouse of Alexandria.
Graham.
Graham Goodisson (FSP95428) is a Financial Adviser with Velocity Financial (FSP95466). No investment decision should be taken based on the information in this blog alone. Please see Graham’s disclosure statement on our website.
About Graham
Hi there, I’m Graham and I started Velocity Financial nearly 20 years ago. I had for many years been running youth development programmes for The Salvation Army and I liked the idea of continuing to help people thrive in other areas of their lives. It started with helping first homebuyers, and I now work mostly with business owners. This is around planning, lending, and managing risk for them and their staff. I’m passionate about community and connecting those in need with opportunity. I’ve been very privileged to do this in my previous career, now in my business and also for 20 years as a Trustee of the Te Aro Health Clinic. Our clinic delivers high quality healthcare for Wellington's most vulnerable and I'm very proud of the fact that Te Aro is now an integral part of Wellington City Health system. I work in New Zealand's two best cities, Tauranga and Wellington. In Tauranga I swim, bike and run (maybe YOGA if I'm feeling particularly aware!) and in Wellington I mostly seem to buy my adult children dinner and drinks.