Every one of us have goals we want to achieve in life. We may want to travel and be awe-inspired by the magnificent beauty of nature and impressive feats of architecture by mankind around the world. It is also exhilarating to discover new cultures and traditions and make new friends while globetrotting. We want to visit The Eiffel Tower in Paris, Grand Canyon in USA and The Great Pyramids Of Giza in Egypt! Alternatively our goal could be to reach out to a group whom we want to help and set up a home for our beneficiary. They could be animals, children, community, elderly, family and those with special needs.
However, have you considered the monetary cost in realising your dreams? Just discovering Italy and taking in the beautiful sights of Canal Grande in Venice, Leaning Tower of Pisa & The Colosseum in Rome will set you back at least S$5000. Starting a charity easily requires a six figure sum. While we are very clear on the reasons and purpose behind our personal goals, we have not considered the cost to achieve them. Having the required budget is a key factor and is usually the only reason why we are not able to attain our goals.
Power of Compound Interest
Knowing how to manage our finance allows us to make the best use of our money and learning how to invest can help us. Investing gives us the power of compound interest. Compound interest is able to magically turn a little money into a large pile of cash! The secret of compound interest lies in the fact that we only earn interest on our initial investment in year one. However in year two, we earn interest not only on our initial investment but also on the interest we earned in year one! This process carries on year after year. Similar to a snowball, it (our interest earned) continues rolling on down a snowy mountain and gets larger and larger until it becomes an avalanche!
Rule of 72
The Rule of 72 is a popular and very easy financial method used to calculate how long it takes to double our investment.
No. Of Years to Double Investment = 72 / Investment Rate (%)
For example, if we are able to achieve 10% returns annually, we will take 72/10 = 7.2 years to double our investment.
Now try it on your own! This rule is a great way to remind ourselves on how fast our money and multiply if we are to put it into good use!
This is how we compute our return if we begin to invest $1000 yearly starting from December 2010 (20 years old), at a return of 10% per annum.
Initial Investment in Dec 2010 = $1000
Interest Earned in 2011 = 10% x $1000 = ($100)
Amount at Dec 2011 (Investment in 2010 + Interest Earned in 2011 + Investment in 2011) =
$1000 + ($100) + $1000 = [$2100]
Interest Earned in 2012 = 10% x [$2100] = $210
Amount at Dec 2012 (Amount in 2011 + Interest Earned in 2012 + Investment in 2012) = $2100 + $210 + $1000 = $3310
We can see the power of compound interest in action. By investing $3000 over 2 years, we are getting a return of $3310 at the end (22 years old).
The table below shows the power of compound interest of investing $1000 each year at investment returns of 3%, 5% and 10% p.a as compared to the meagre 0.1% p.a interest rate our local banks are offering for saving deposits at the moment.
|Age||Bank Savings Deposit 0.1% P.A ($)||3% Investment Returns ($)||5% Investment Returns ($)||10% Investment Returns ($)|
By setting aside just $1000 a year (less than $100 a month) we can achieve a whopping return of $791,795 after 45 years, that is 16 times more than putting our money in a savings deposit! Imagine how much more we can get in return if we are to invest more than $1000 a year at a higher rate of return!
Taking Advantage of Compound Interest
1. Begin Early!
From the table, we can see that at 10% returns, if we delay and invest 5 years later, it could mean a difference of receiving $487,852 as compared to $791,795! Hence, to reap the full benefits of compound interest, we need to start early. If we put it off any further, we may just miss the boat for that additional $303,943 windfall!
2. Take Small Steps
By setting aside less than $100 a month, we have seen that we are able to get back in return of $791,795. Even if we just staying invested for $50 a month, we can receive $528,000 when we retire (say 65 y.o)! That is pretty good for not having to do any work and just setting aside some of our pocket money!
Risk Comes From Not Knowing What You Are Doing
Everyone knows the importance of financial knowledge but most of us are not willing to take the first step and study the ropes of finance. It is not that difficult to begin. Investing has always been perceived as being risky, we have seen the most experienced of analyst losing all they have. It was due to greed and fear. Personal finance is not about a game of luck but in fact it is about learning the rules and strategies to remain in the game of investing. Those who play by the rules in this game will turn out winners.
It requires expertise to achieve 10% returns but it is certainly possible for us to achieve 3% and 5% in returns. Having $168,685 (5% return) certainly beats having $47,050 (0.1% return) when we retire. As the Mandarin saying goes, “If you are not bothered about wealth, wealth will leave you.” All we need to put in some effort into learning and we can better help people whom we care for and travel the world. It is not a good excuse not to invest if you do not know how. However, it is a great reason to find out more about how to make good investment decisions.
Royalty-free photo from Getty Images. Used with appreciation.
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