The Power of Compounding

27 11 2014


The proverb ‘the early bird catches the worm’ is not only true to work but also when it comes to investing. Most people prefer instant gratification especially if they worked really hard for that money. They need to instantly gratify themselves in order to savor the rewards of their hard work.

One of the ways to instantly gratify one’s self is shopping. With the rise of e-commerce nowadays, it has become more convenient. In just a few clicks of the mouse and an internet connection, you could purchase the things that you want and have it delivered at your doorstep without the hassle of going to the physical stores of retailers.

However, if you prefer to delay your gratification, and you choose instead to save and invest, then you are on the right path towards financial freedom.

I was recently featured in ANC ‘On The Money’ for the second time and I discussed the power of compounding. Compounding, in investing, is simply the interest of an interest. We commonly hear it when we have our savings park in the bank and watch it grow as time passes by. However, compounding is not always beneficial for us and this is true especially if you have loans left unpaid.

Credit cards are known to be the easiest sources of debts. Like any other unpaid loans, it would incur interest and penalties if left unpaid at a staggering 3.5% monthly. This compounding interest rate will drown you into mounts of debt. Time will be against your side if you have unpaid interest-bearing debts.

In contrast, if you are an investor, time will be your friend when it comes to compounding. The earlier you started investing, the more the potential for your money to grow. This is clearly seen on the image below.

Using a fixed 10% compound annual interest rate, a person who started investing Php 5,000 at an early age of 25 and kept investing for 10 years would have Php 20 million by the time he reached the retirement age of 65. Using the same scenario but at different starting age of 35 which is 10 years later than the first, the person would only have Php 7 million by the time he reached the retirement age of 65.  That’s the opportunity loss, a difference of Php 12.4 million in just a span of 10 years of being late to invest.

Invest 1

Do you want to become a millionaire? The power of compounding works to your advantage. The earlier you started investing, the earlier you will achieve your millionaire status. The table below shows the amount you need to save monthly at given age and interest rates in order to become a millionaire at the retirement age of 65.

Notice that the younger you are, the lower the amount you need to invest monthly. Conversely, the older you are, the higher the amount you need to invest monthly because you are running out of time already.

Invest 2

True enough, the early bird catches the worm. It’s not how much you earn but how much you save and invest. If you are the ‘early bird’ in investing, then you would catch the ‘worm’ sooner than the rest of your peers.



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