Compound Interest, The 8th Wonder Of The World!

Wikipedia describes compound interest as:

Compound interest arises when interest is added to the principal of a deposit or loan, so that, from that moment on, the interest that has been added also earns interest.

This addition of interest to the principal is called compounding.

A bank account, for example, may have its interest compounded every year: in this case, an account with $1000 initial principal and 20% interest per year would have a balance of $1200 at the end of the first year, $1440 at the end of the second year, and so on.

And it was Albert Einstein said:

"Compound interest is the eighth wonder of the world.

He who understands it earns it... he who doesn't... pays it."

Let's look at some numbers so we can see compound growth in action.

If I were to ask you which option you'd prefer, how would you (honestly) answer:

1. 1p that doubles every day for a month

2. £1m cash in your bank account immediately

Now, you may be thinking that this is obviously a leading question and you'd be correct! But I'm guessing if the question was asked out of the blue many would opt for 2.

In fact, option 1 would return in excess of £10m!

The power of compound interest at work.

I'll admit that it's unreasonable to expect a 100% return on any investment every single day, however, it's the principle that I want to concentrate on.

In effect, all interest earned on any investment is effectively free money and interest earned on interest is the holy grail.

The 3 Rules

The amount of money you'll get back on any investment is determined by:

1. The amount you invest

2. The length of time your money is invested for

3. The rate your money grows at

Back to some numbers.

Let's say you have a target of £300,000 at age 60.

Age     Years to 60     Growth Rate     Monthly Payment     Total Invested 

30             30                      5%                        £366                 £131,760

40             20                      5%                        £736                 £176,640

50             10                      5%                        £1,936              £232,320

So as you can see, the longer you leave it the more it'll cost over the long term.

Looking at another example, let's say you invested £366 per month between the ages of 30 and 40 but then stopped.

Here's how the numbers look:

Age.......................30..............40..........50

Years to 60............30..............20..........10

Growth Rate..........5%.............5%..........5%

Monthly Payment...£366..........£369........£971

Total Invested.......£43,920.....£88,560.....£116,520

Maturity Amount...£150,513....£150,513....£150,513

As you can see, the 'cost of delay' is stark, so if you can afford to invest more at an earlier age you'll save a hefty sum, all factors being equal.

So, time indeed can be your friend when investing.

Looking at rule 3, how do the numbers look if the return is 7% pa? (remember, the target is £300,000)

Age.......................30..............40...........50

Years to 60............30..............20...........10

Growth Rate..........7%.............7%..........7%

Monthly Payment...£255..........£588........£1744

Total Invested.......£91,800.....£141,120...£209,280

As you can see, there's not a huge saving if you start investing at 50 (10%), however, it's a different story at age 30 where you'd save 30%!

And what about the cost of delay example at 7% pa where you invest the £255 per month between the ages of 30 and 40 but then stop?

Age.......................30..............40...........50

Years to 60............30..............20...........10

Growth Rate..........7%.............7%..........7%

Monthly Payment...£255...........£333........£987

Total Invested.......£30,600......£79,920....£118,440

Maturity Amount...£169,738.....£169,738..£169,738

You get the point, I'm sure.

Whilst there are a number of factors you should take into account before you invest, some of the key ones are (in no particular order):

- Inflation

- Investment fees

- Transaction fees

- Adviser fees (if you use one)

- Product fees

- Tax

Key Considerations

It's not always easy to invest the amounts you want when you have other commitments, however by budgeting and being more aware of where you're spending your money it's possible to find additional sums each month.

Action Point

If you do want to analyse where your money goes each month, the tool we recommend is You Need A Budget.

After all, if you're able to invest another £100-£200 each month you'll be able to (potentially) enjoy the benefits of the 8th wonder of the world!

Ray Prince is a fee-based Certified Financial Planner with Rutherford Wilkinson Ltd and helps UK Resident Doctors and Dentists plan to achieve their financial objectives. Just visit http://www.medicaldentalfs.com where you can request your free retirement planning guide.

Rutherford Wilkinson ltd is authorised and regulated by the Financial Conduct Authority.

Credit: Ray Prince

Compound Interest Vs Compound Growth

I hear people say all the time that the most important thing to teach kids about money is the power of compound interest. But really, that's not the true picture of why investing works and why our money grows over time. It's not actually always compound interest that creates wealth...at least not for many investors. It's actually 'compound growth' that causes money to grow in many instances. Let me explain.

Let's divide this conversation into the three main areas of investments which in our programs we call the Three Pillars of Wealth: business, real estate and the stock market.

Let's start with BUSINESS. Think about how people profit from owning businesses. The reason they do is many-fold:

o The business appreciates in value and is sold for a profit.
o The business is able to be put on autopilot and create passive income.

In these two cases, compound interest has absolutely nothing to do with the wealth a business can create UNLESS the business is in the business of lending money and charges compound interest on that money. Examples would be banks, credit card companies, private lending companies, mortgage companies. You get the idea.

Next, let's look at REAL ESTATE. The profit from owning or investing in real estate comes from:

o The property or building appreciates in value and is sold at a profit.
o The property is rented out for more than the expenses on it producing a positive cash flow the owner can live on.

These two methods of making money on real estate have nothing to do with compound interest, UNLESS you're lending money to someone who is buying the house and you're changing compound interest on that loan or you're carrying the paper (playing the bank) on a piece of property you're selling.

Lastly, let's look at the STOCK MARKET. Once again, very little profit and wealth that is created in the stock market has anything to do with compound interest. The wealth that is created is because:

o The stock or mutual fund you're invested in grows in value because the cost of the stock or mutual fund (NAV in case of the mutual fund) goes up and you sell it at a profit (or vice version because you are selling short...more on that later)
o The dividends you may be receiving from the stock or mutual fund are 'reinvested' in more of the same stock or mutual fund providing a compounding effect, but it's not interesting per se.

Bonds are another type of investment where the money you make can be interest, but it's not always interest that makes you money when investing in bonds. Confused? That's OK, so was I when I first learned about bonds. Much of the actual profit made on bonds is due to people buying and selling the actual bonds as the cost of those bonds goes up or down, just like the price of a stock goes up and down. Still, if you're the holder of a bond, you do make interest in the bond itself.

So, is it important that kids of all ages learn about compound interests? Absolutely AND it must also be combined with the idea that the power of money to grow over time is called Compound Growth. The definition of compound growth is "a measure of how much something grows per year, over a multiple-year period, after considering the effects of compoundING.

An extension of this topic, if your child is old enough and ready for it, is the conversation about 'return on investment' and 'rate of return.' I have asked many experts if these two phrases mean the same thing and I always get a mix of answers; some say yes and some say no. Most say that ROI is the actual bag of cash returned from an investment and ROR is the measured rate, expressed in a %, at which the investment returned a profit.

The general question is simply, "How much money has my money made over time and how do you turn that into a percentage rate per year?" According to Wikipedia, the ROI or ROR is the RATIO of money gained or lost on an investment where the money invested is referred to as the asset, capital, principal or cost basis of the investment. To figure your ROI or ROR you simply...

Divide the amount of money you made by the total investment made. Example: Let's say you invest $50,000 and a year later you get back $60,000. Your profit is $10,000 (not factoring in any taxes or other fees).

Your RETURN = $10,000/$50,000 or 20%. Pretty straightforward, yes? And remember, rates of return are usually quoted per year, but not always. What if you have an investment that pays you 30% every six months? Well, is that a total of 60% per year? Maybe, maybe not. In order to get a total return for a year, you have to do the math based on the figures for the year. It makes sense that it would be 60% but sometimes it just doesn't turn out that way.

Now for some cold hard facts about the actual compound interest that we share with our attendees to Camp Millionaire and Creative Wealth for Women.

CREDIT CARDS: Let's say you buy a new stereo for $1000. You put it on a credit card that charges 19% interest per year. You only pay the minimum payment on this card. Ready for the shock?

It took you 19.3 years to pay it off and you ended up paying $2930.00 for it!!!

YOUR MORTGAGE: Let's say you buy a house for $300,000. You borrow $250,000 from the bank at 6% interest and it's a 30-year loan. Do you have any idea how much that house cost you? Are you sitting down? $539,596.80!!! You paid more interest on the loan that you originally borrowed.

Should you never buy a house then? No, but you should consult your accountant to find out if it's the right thing to do financially. We teach our campers to buy rental properties first and then buy the house they live in with the passive income from their rentals. Put your money to work for you first!

OK, that's all for today in terms of this compound interest concept. Just remember that isn't always compound 'interest' that is making your money grow...sometimes it's compound growth based on appreciation, cash flow, profits, rents, dividend reinvestment, and more.

Credit Elisabeth Donati

Compound Interest Formula - The Magic Formula for Becoming Rich and Building Wealth

When it comes to becoming rich / building wealth and the importance of regular saving and investing, you simply can't afford to talk about the power of compound interest. You know, I'm not sure if you can get rich quick (unless your definition of quick is 10 years or so); however, if that is your goal, then Compound Interest is the magic bullet of your savings and investing strategy.

Compound Interest - The 8th Wonder of the World

Albert Einstein famously referred to it as the 8th Wonder of the World and even went as far as saying that "the most powerful force in the universe is compound interest". Einstein, you could say, was smarter than the average bear!...so if he thought that there's got to be something behind what he called the "greatest mathematical discovery of all time". For something so powerful, the maths behind compound interest is truly very simple. It is just interest earned on top of principal and interest i.e. interest accruing not only on the initial principal deposit you invested but also on the accumulated interest over time. This creates a snowball effect so that, as your capital rolls down the hill, it gathers more and more interest until you end up with a very large snowball indeed. The really great thing about compound interest is you don't have to do a crash-course in momentum stock trading or leveraged property investing to avail of this wonderful little financial miracle. Compound growth is available to EVERYONE the day you make a decision to utilize it i.e. the day you start saving and investing.

The Magic Formula!

Where the interest is compounded once a year then the Compound Interest Formula is: A = P(1 + R)Y whereby:

·       A = the accumulated amount i.e. how much money you've accumulated after n years, including interest.

·       P = the principal (the money you start with, your first deposit)

·       R = the rate of interest (AER) as a decimal (8% means =.08)

·       Y = the number of years you leave it on deposit

The Two Levers of Compound Interest: Frequency & Time 1. Frequency (or Interval)

In the above example, we are simply compounding annually. But some savings and investments may compound quarterly or even monthly. So, it's important to find this out in advance from the financial institution or broker. The frequency with which returns are compounded is particularly important when investing in Bonds. The following shows the difference in how the formula is calculated.

·       Quarterly Compounding = P (1 + R/4)4

·       Monthly Compounding = P (1 + R/12)12

The more frequent the interval of compounding is, the greater the impact on compound growth. However, it's worth noting that although the frequency is an important lever in the impact of compounding on the future value of a savings or investment vehicle, it is not as impactful as the term i.e. length of time (plus the compounding frequency "lever" is subject to the law of diminishing returns over time).

2. Time (i.e. the Term)

Compounding exerts its most dramatic effect (for a given interest rate) when the term is extended. In other words, the longer an amount is subject to compounding, the greater the effect. If you invested $10,000, using the above formula, compounding interest at 8% per annum, over 10 years only, the future value would be $12,597. However, taking the same principal sum and interest rate, but compounding over 25 years, the future value would be $21,589! So, as you can see, the effect of term length is remarkable: the original sum of $10,000 doubles in less than 10 years and increases more than sevenfold in 25 years How to Guarantee You'll Become a Millionaire If you are a long-term convert to the habit of saving and investing, then you will have no doubt discovered that compound interest is your long-term best friend on the road to wealth creation. The best thing about compound interest is that it is your money working for you rather than the other way round. Pocket change can literally turn into millions over 20 or 30 years. Did you know that if you invested just $5,000 per year at an average return of 7% from the age of 25 you'd be a millionaire by the time you hit 65. Ok, so inflation would eat away at the real value of those million dollars after 40 years but it proves the point that over time, the regular saving of quite small amounts can build up an astonishing sum of money. The secret to reaping the benefits of compound interest is:

·       Saving and/or Investing a regular amount of money each month.

·       Leaving you money invested for the long-term.

·       Reinvesting your gains (interest), again and again.

Conclusion:

So, compound interest allows you to get rich slowly over time, but you can speed up this process and get rich quicker by pulling on the two levers of frequency and time. Of course, maximizing your interest rate by choosing the right investment vehicle in the first instance is also a big factor. However, the key take-home message in all of this is, leaving aside interest rate, the amount of capital (principal) you start with is not nearly as important as time i.e. getting started early. Remember, the great thing about compound growth is that this "magic formula" is available to EVERYONE i.e. YOU, the day you make a decision to utilize it!

P.S. Visit MillionaireMindsetSecrets.com and sign-up for FREE insights, tips and exclusives on Compound Interest Formula- utilizing our powerful income and wealth creation strategies can fast-track your wealth-building so that you get rich for life and build wealth that lasts.

Credit:  Keelan Cunningham 

New Stock Ideas: A Guide to Some of the Best Industries for Beginners to Invest In

Are you new to investing? 2019, overall, has been pretty good to shareholders. The best stocks to buy are strong companies with a solid foundation, expected to prosper no matter what the future holds. Even though the trade wars are stirring up a lot of concern, there are still some relatively safe stocks, some of which are under the radar. To give you a starting point, here are some new stock ideas to think about.

Cloud / file hosting technology

Dropbox (DBX) in particular, has a 112% upside. The company seems to be stabilizing thanks to new product offerings and pricing in order to better serve the needs of its 500 million+ registered users. The virtual storage needs of many people are growing so much that free accounts aren't sufficient enough anymore, which means that the number of paid subscriptions is growing.

Wind energy

Wind energy projects are becoming more pervasive in a number of countries. This clean, sustainable source of energy is considered a good long-term prospect. There is potential that the operating costs are declining, and the pricing seems to be stabilizing.

Australian Housing

If you're looking for new stock ideas in real estate, consider the metropolitan areas of Melbourne and Sydney. They are short of rental supply and the population is growing due to immigration. There has been a lot of money put into Australia from foreign countries like China. If you are interested in the Australian real estate market, keep rental properties at the top of your priority list.

Waste management

This isn't the most glamorous industry to invest in, but with an increase in environmental services, pollution control, and recycling centers, it is reasonable to see the value in investing in this side of the industrial sector. It is a necessary part of everyone's lives. A couple of organizations to look including US Ecology (ECOL) and Waste Management (WM).

Aerospace sub-sector

There has been a boost in US military spending this past year, so it might be worthwhile to put money into companies that are part of the supply chain, such as designers and developers. The aerospace industry typically performs well in late economic cycles. As the cycle matures, there is an increase in plane orders and a good way to play it safe is by investing in the suppliers.

Credit George Botwin

Timing the Markets

Time or Timing in the markets

How important is it for investors to time the markets?

I know a retired man who cashed up his superannuation to purchase a car at a time when the markets were running hot. This was in February 2020 just as covid-19 was starting to spread throughout the world. The following month the markets started to slide. I told him, "no wonder you are smiling."

That was good luck rather than good management, but you could consider it good timing even though it was a fluke.

There are other cases of investors who were not so lucky.

One was an investor who changed from growth funds to conservative funds during the market slide only to find that they missed out on all the gains when the market recovered, losing them thousands.

Another is an investor who used some of their retirement funds for a deposit on a house as they can do with kiwi saver, the New Zealand retirement savings scheme. That sounds fine, but they withdrew the amount they were able to during a time when the markets were falling, and the losses were said to be fifteen grands. Just like the other investor who changed funds this investor also missed out on the gains when the markets recovered.

The property market in New Zealand went crazy during 2020 due to the number of New Zealanders returning home and buying houses. A lot of people jumped on the property buying bandwagon. It is the F.O.M.O factor at play here. FOMO, for those who do not know stands for, "Fear of missing out."

One common theme coming out of all of this is that the property market is out of reach for first home buyers. It is still important for people to build up their asset base and find alternative ways to invest their money because having assets behind you puts you in a greater position financially for whatever is down the track.

The key to investing is to do it the right way. You would not invest in growth funds if you were going to use the money for another purpose in the short-term because the markets could take a fall just prior to you withdrawing the money. On the other hand, if you have time on your side then investing in riskier funds may be an option if you have the temperament to handle the volatility.

An investor needs to decide whether this money is going to be used in the long-term, medium-term, or short-term and set their goals accordingly. An investor's risk profile is another factor to consider; it is easy to be an investor when the markets are going up but if the rollercoaster ride of growth shares is going to cause you to lose sleep then you need to be a little more conservative.

The investor who switched to more conservation funds when the markets were heading south and missed out on the gains when they recovered allowed their own emotions to get the better of them. It is important for investors to get over themselves and train themselves to invest with the right mindset.

There are so many options available for savers to invest their money and where to invest depends on everyone’s personal circumstance. It is up to savers to do their homework and read all they can about the markets.

Credit : Robert Alan Stewart

 

The Way to Financial Freedom and Independence

Everyone wants to be financially free and independent. But such does not just happen. There are things you need to do intentionally. Maybe you may say it is too late to start on such. But it is never too late to start on something that leads to freedom.

This article is about the steps to that financial freedom and independence. It shall cover; putting in place a savings plan, dealing with debt, and using your savings to invest. Let us now look at the steps:

1. Put in place a savings plan.

Financial saving is about putting some funds aside for future needs. It is the starting point for those who do not have a good financial background to their financial freedom and independence.

This is paying yourself first. It is unfair to oneself to start paying everyone else after getting a salary or earning money except oneself. How do you do that? You start by paying rent, tithes, paying debts, utilities and other things until your monthly earnings are depleted. So, saving at least 10% on every income you get is a great starting point. This is affordable for everyone since it is proportionate to your income. There can be no excuse.

What are you waiting for? Start right away. Open a savings account by joining a savings and credit cooperative or use a bank. Avoid withdrawing those funds until a certain given period.

2. Deal with debt

We all want to use debt at a given period. However, there is good and bad debt. I term bad debt as that, which does not generate income for you. Good debt is that which is used for productive purposes like starting some income generating projects.

Bad debt adds liability to you. Note that I am not using these terms as per the accounting terminology. So, an asset that is a liability is one like a car or house for personal residence. Why term these items like this since they are known as assets? They are a liability because they take cash out of your pocket.

Over indebtedness should be avoided at all costs. If possible, reduce and do away with debt. The savings plan mentioned above shall take you to financial freedom and independence when followed consistently.

3. Use your savings to invest.

Investment is better than savings. However, you need to first have some funds before you can invest. Unfortunately, that is where most of us must start from. There are several ways in which you can invest your funds. The ways may include, business, buying financial assets, investing in financial stocks, property, etc.

Investing helps you build your wealth, thus giving you your financial freedom and independence. It is a way of growing your finances.

The above three steps shall help you start on your journey to financial freedom. Just follow them. Start by setting up a savings plan and follow it consistently. Do not wait long because there will never be a favourable time. Work on your debt by following a repayment plan. Then invest your funds so you can grow your finances. Those three steps shall indeed put you on the right track to financial freedom and independence.