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Compound interest is all about time. Investors can only see its effects over the
long-term. Take for example a stock investor who adopts the long-term strategy of
buy and hold. Over short periods, his or her stocks would only produce a little extra
return but over the long-term, the stocks would produce incredible results if the
gains are reinvested.
According to Ibbotson and Associates, the annualized returns for U.S. stocks and
bonds from 1926 to 1996 are 10.7% and 5.1% respectively. Let us examine the impact
of compound interest on an investment of $15,000 over say 40 years assuming the above
historical returns.
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Bond portfolio
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= $15,000 x (1.051)40
= $ 109,698 |
|
Stock portfolio
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= $15,000 x (1.107)40
= $ 874,976 |
Note: For illustration purposes only
Past performance is no guarantee of future results
Your bond portfolio will give you a return of over 600% while
the stock portfolio will deliver an incredible 5,733% return over the period. Clearly,
the 5.6% difference between stocks and bonds makes a big difference over a longer
time frame. However, you have to take into consideration the impact of inflation.
The returns achieved would be lower if you factor in inflation.
The benefits of starting early to realize the impact of compound interest cannot
be denied. If you start early, the amount of money that you can accumulate will be
greater. Time can be the greatest ally of any investor. Just a few additional years
can make wonders to your portfolio.
Procrastination will never build your money. Make it a point
to teach your children to save from the early days. Show them how the money that
they put in the bank will grow over the years. Table 1 shows the compound impact
of an annual contribution of RM4,000 at the beginning of each year over a period
of 30 years using different interest rates.
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Table 1. The Power of Compound Interest
|
|
Year
|
7.00%
|
8.00%
|
9.00%
|
10.00%
|
11.00%
|
12.00%
|
|
1
|
4,280.00
|
4,320.00
|
4,360.00
|
4,400.00
|
4,440.00
|
4,480.00
|
|
2
|
8,859.60
|
8,985.60
|
9,112.40
|
9,240.00
|
9,368.40
|
9,497.60
|
|
3
|
13,759.77
|
14,024.45
|
14,292.52
|
14,564.00
|
14,838.92
|
15,117.31
|
|
4
|
19,002.96
|
19,466.40
|
19,938.84
|
20,420.40
|
20,911.21
|
21,411.39
|
|
5
|
24,613.16
|
25,343.72
|
26,093.34
|
26,862.44
|
27,651.44
|
28,460.76
|
|
6
|
30,616.08
|
31,691.21
|
32,801.74
|
33,948.68
|
35,133.10
|
36,356.05
|
|
7
|
37,039.21
|
38,546.51
|
40,113.90
|
41,743.55
|
43,437.74
|
45,198.77
|
|
8
|
43,911.95
|
45,950.23
|
48,084.15
|
50,317.91
|
52,655.89
|
55,102.63
|
|
9
|
51,265.79
|
53,946.25
|
56,771.72
|
59,749.70
|
62,888.04
|
66,194.94
|
|
10
|
59,134.40
|
62,581.95
|
66,241.17
|
70,124.67
|
74,245.72
|
78,618.33
|
|
11
|
67,553.81
|
71,908.51
|
76,562.88
|
81,537.14
|
86,852.75
|
92,532.53
|
|
12
|
76,562.57
|
81,981.19
|
87,813.54
|
94,090.85
|
100,846.55
|
108,116.44
|
|
13
|
86,201.95
|
92,859.68
|
100,076.76
|
107,899.93
|
116,379.67
|
125,570.41
|
|
14
|
96,516.09
|
104,608.46
|
113,443.66
|
123,089.93
|
133,621.44
|
145,118.86
|
|
15
|
107,552.21
|
117,297.13
|
128,013.59
|
139,798.92
|
152,759.79
|
167,013.12
|
|
16
|
119,360.87
|
131,000.90
|
143,894.82
|
158,178.81
|
174,003.37
|
191,534.70
|
|
17
|
131,996.13
|
145,800.97
|
161,205.35
|
178,396.69
|
197,583.74
|
218,998.86
|
|
18
|
145,515.86
|
161,785.05
|
180,073.83
|
200,636.36
|
223,757.95
|
249,758.72
|
|
19
|
159,981.97
|
179,047.86
|
200,640.48
|
225,100.00
|
252,811.33
|
284,209.77
|
|
20
|
175,460.71
|
197,691.69
|
223,058.12
|
252,010.00
|
285,060.57
|
322,794.94
|
|
21
|
192,022.96
|
217,827.02
|
247,493.35
|
281,611.00
|
320,857.24
|
366,010.34
|
|
22
|
209,744.56
|
239,573.18
|
274,127.75
|
314,172.10
|
360,591.53
|
414,411.58
|
|
23
|
228,706.68
|
263,059.04
|
303,159.25
|
349,989.31
|
404,696.60
|
468,620.96
|
|
24
|
248,996.15
|
288,423.76
|
334,803.58
|
389,388.24
|
453,653.23
|
529,335.48
|
|
25
|
270,705.88
|
315,817.66
|
369,295.91
|
432,727.06
|
507,995.08
|
597,335.74
|
|
26
|
293,935.29
|
345,403.07
|
406,892.54
|
480,399.77
|
568,314.54
|
673,496.03
|
|
27
|
318,790.76
|
377,355.32
|
447,872.87
|
532,839.74
|
635,269.14
|
758,795.55
|
|
28
|
345,386.12
|
411,863.74
|
492,541.43
|
590,523.72
|
709,588.75
|
854,331.02
|
|
29
|
373,843.15
|
449,132.84
|
541,230.15
|
653,976.09
|
792,083.51
|
961,330.74
|
|
30
|
404,292.17
|
489,383.47
|
594,300.87
|
723,773.70
|
883,652.70
|
1,081,170.43
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Note: Amount in Ringgit
Compounding is the key element in building wealth. Through the magic of compound
growth, an investment can grow to many times its original size. All it takes is time.
It is never too late to start saving for the future. Put the power of compound interest
to work for you and your financial goals. Only the early birds will reap the maximum
benefits from the effects of compound interest.
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