Before we bid 2014 goodbye, here’s an obligatory post on compounding.
A year older, hopefully a year wiser and another year of compounded income.
Compounded interest is a very powerful tool that many of us tend to ignore even if we don’t need to exert much effort to make it work for us. All we need is for time to make our investments grow on the side.
In fact, many quotes on compounded interest have been attributed to Albert Einstein because of the sheer brilliance of the two (despite the disputes on its accuracy). Quotes such as the one above.
I’ve seen various versions of the following illustration from other personal finance websites so here’s my own rendition.That’s why I call this an obligatory post.
We have three scenarios named Juan, Maria and Jose. Their investments are all assumed to grow at 10% annually (which is average and achievable), then compounded every year thereafter. As follows are the details:
Started to invest at 20 years old, PHP1K a month so equivalent to PHP12K a year. (Doable?) Stopped investing by age 30, for a total of 11 years of investing.
By the time they retire at 65 years old, which one do you think has the biggest retirement fund? Let’s find out from the table below.
Juan’s investment reached PHP6.87M, Maria’s at PHP6.25M while Jose only at PHP4.80M. Juan’s cash outlay is only PHP132K, Maria’s at PHP225K while Jose at a whopping PHP744K.
Juan’s investment multiplied 52x by age 65, Maria’s 28x while Jose, sadly only at 7x.
Juan’s investment started the earliest but it was the smallest amount. Still it beat a bigger amount and a longer investment horizon (Maria’s 15 years and Jose’s 31 years!)
Compounded interest proves a Filipino saying: Daig ng maagap ang masikap. Rough translation goes something like “The early Juan beats the hardworking Juan.” What more if you are both early and hardworking right? As I often say, don’t just work hard, work smart. Smart such as starting early on.
Below is a graphical visual representation of above points:
Investments grow exponentially but Juan’s still end up as the highest by age 65. This just shows that there is nothing wrong with starting small. What matters is starting early.
What’s best is starting early, even if small, increasing the regularly invested amount as cash flow grows, and continuous investing even beyond 30s, 40s. Even beyond 60s. In fact, if Juan continued to invest PHP12K until age 65, his investment will reach PHP10.4M and yet his cash outlay is still lower compared to that of Jose (PHP552K vs PHP744K).
Juan cannot bring back time, but Juan can always start now. And as we approach another new year, may compounded interest be your ally in the years to come.