Einstein also referred to compound
interest as the 8th Wonder of the World.
Why? What is it about compounding that
makes it such a powerful force?
The word ‘compound’ is used
to describe the process where interest
is earned on the invested capital amount
as well as on the previous interest that
has been earned. In other words, when
you earn ‘interest on interest.’ It
is the road to long-term riches that
has been discovered and travelled by
the world’s most successful investors,
and mum and dad investors too.
To access the power of compounding you
need to be prepared to make some sacrifice
to make the initial investment, and then
have enough time for the miracle of compounding
to do its work.
We came across a great example – almost
unbelievable – of the power of
compounding, so we thought that we would
share it with you, and add a table as
proof!
Let’s assume Investor B opens
an investment savings account at age
19. For seven consecutive years he invests
$2000 at an average growth rate of 10%
and then makes no more payments.
In contrast, Investor A makes no contribution
until age 26 (which is the age Investor
B is when he makes his last $2000 investment).
Investor A then contributes $2000 a year
every year until he is 65, also at an
average growth rate of 10%.
The results are astounding: despite
only making 7 payments, but by making
them earlier, Investor B ends up making
more money than Investor A, who started
later but who made 40 contributions of
$2000 each!
Yes, it seems unbelievable, so check
the table alongside for the evidence.
This is the ultimate proof of the saying, “time
is money.”
In the case of investment property,
the long-term trends show property doubling
in value every 7 to 10 years. This means
that the growth in value is compounding
as per the example above.
Compounding shows the remarkable time
value of money, and is a core reason
why investing in a growth asset is a
decision not to be delayed.
INVESTOR A vs. INVESTOR B
- Investor A puts in $2,000
a year for seven years.
- Investor B puts nothing in
for seven years, then puts $2,000 a
year in
for the next 40 years.
- Investor A ends up with more,
due only to the effect of compounding
returns.
By starting early, 7 years of investment
is worth more than 40 years of investment. If you would like to learn more and discuss
how McCarthy Group can assist you, click
here.
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