One of the most important investment lessons – the power of Compound Interest
Here is the key message right up front: Small actions taken consistently over time can have a substantial impact.
This is so important for anyone looking at their existing investment portfolios and for those who are still caught up in the inertia of wanting to start but who have not got around to it yet.
Where to start?
Start with your targets, your goals. An investment is a means to an end to deliver what is truly important and meaningful to you, so you need to identify those key drivers. They may be income stability in retirement, purchasing a house, the ability to take a year off to travel when you are 60, or even a defined lump sum by a certain age. It doesn’t matter what it is, it just has to be your raison d’être.
When you know what you want and your investment has purpose, then you can work towards the goal. The key message of this article- that small actions taken over time can have a large impact- can drive your long-term investment in two ways.
1. By adding to your investment regularly, the final result can be much greater. Small additions monthly or quarterly taken over a period of time can have a big impact.
2. The exponential growth curve of Compound interest. Compound interest is simply interest on your interest, so if you are reinvesting your dividends and achieving capital growth over time your asset will grow progressively faster.
Together these components can see you achieve your targets.
Here is an example of the impact:
It shows two very important variables. Investing €1000,000 for 20 years versus investing the same amount plus adding €1,000 per month. The ongoing investment additions can more than doublethe end result with all other variables like costs and return the same.
There is also a second important consideration, and that is dividend reinvestment. By taking the dividends as income along the way the potential investment can be reduced by over one third. Now many readers will argue they wouldn’t take dividends from their investments as the purpose is not to produce income now but to achieve a longer-term target. However, be aware, this is exactly what we do when we invest in property. We collect the rental income, which is the dividend payment, and use it to supplement our income or cover the costs of owning an investment property. Property investors, overtime may realise the capital growth by selling it for more than we purchased it and that is great, but they should also look at putting that dividend income to better use. Property remains a good asset class and an important part of a diversified portfolio but be aware of this. If you have investment properties, you might want to consider a separate investment to build up your dividends- the rental income- over time.
The other aspect of compound interest is that all the excitement happens towards the end, so it is important to stick at it. The growth is exponential.
Here is an extreme example. If you started with €1 and doubled your money every day for just one month, after 31 days you will have over €1 billion! Of course, we are not going to get 100% return consistently but it illustrates the point. The first 25 days don’t look very exciting, but the end result is extraordinary.
The message is this: be consistent, employ the power of compound interest, don’t delay starting, and focus on your targets, i.e what is really important for you.
The reality is, it is much easier to plan than to do, so the last piece of advice is to get help, from a regulated and qualified professional. Contact us and let us help you to focus on your targets and to achieve your goals.
