'Compound interest is the eighth wonder of the world. He who understands it earns it; he who doesn't pays it.' – Albert Einstein
Imagine if you invest your money at 8% per year, under compound interest you would have increased your investment by 2 times after a 10 year period.
Now take the same concept but for 50 years. Rationally you would think that this would be 10 times since the period is 5 times longer. However, this is not the case. You would have increased your investment by a whopping 47 times.
The above concept is known as compound interest (or Exponential Growth). This concept is a bit confusing to understand, and as Einstein said, if you don’t understand this, you will end up paying it.
As the above example suggests, there are 2 main components of compound interest that make it quite powerful;
The rate of return,
The period in investment.
In our recent blog post, A Beginner’s Guide to Investments: Asset Classes Explained, there are various ways in which you can invest your money to achieve the above concept of return. However, since compound interest is more powerful if the rate of return is higher, and the length of investment is longer, there is one particular asset class that provides the above returns consistently, Equities.
Past data suggests that for investments of over 20 years, the average annual return from investing in a portfolio of listed companies (S&P 500) is on average between 8% and 10%. However, locally, our stock market is not as mature as the US market so you would have to make shifting investment strategies for the long term that the common investor does not know how to.
This is where the concept of a money market fund comes in. According to Investopedia, A money market fund is a kind of mutual fund that invests in highly liquid, near-term instruments. These instruments include cash, cash equivalent securities, and high-credit-rating, debt-based securities with a short-term maturity (such as Government Treasuries). Money market funds are intended to offer investors high liquidity with a very low level of risk. Money market funds are also called money market mutual funds.
Locally money market funds average about 8% return, with some as high a 10% return due to exposure to high yielding alternative assets. This route can give the average investor access to compounding returns without worrying about the nitty-gritty of investments strategy (this is handled by the fund manager), and also the safety of their money.
The above graph shows the vast impact of compound interest over a period of 50 years compared to simple interest. You can be able to play around with compound interest using our intuitive tool, The Bromide Compound Interest Tool. The tool can also guide you on investment decisions.
Bromide helps entrepreneurs and small business set their businesses up for success. Get the technical advice you need to start, grow, and maintain your business today. Check our website and reach out at discoverthebromide@gmail.com.
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