• Monday, February 26, 2024
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BusinessDay

How compounding interest can supercharge your savings

Treasury-Bills

Your savings can make you rich with the help of compounding interest.

Compounding interest can be likened to a snowball rolling downhill. It starts slow, but it quickly grows in speed and size if uninterrupted. This is because the interest earned on the initial deposit gets reinvested, thereby increasing your balance and earning you more interest.

Many parents take advantage of compounding to secure their children’s future. It’s also a good way to prepare for retirement with little amount invested consistently.

For example, Feji Iyeke, a financial advisor, explained how you can gift your child N35. 6 million by their 18th birthday as a trust fund, university fund, or even an inheritance through the principle of compounding.

“By investing N50,000 monthly in the S&P 500 ( a stock index on the US stock exchange) which gives an annual return of 10 percent from the child’s birth till its eighteenth birthday, you’ll have the sum of N35.6 million from the interest made from interests over the years,” he said

He said choosing the S&P 500 was a means to beat rising inflation and devaluation of the naira because it’s a dollar-based asset.

By the calculations, this means for the duration of this period you only invest N10.8 million and get N24.8 million in interest.

At year five it will be worth N4.1 million, while by 11 years it will be worth N11.5 million, and by 14 N20.7 million.

Charlie Munger once said, “The first rule of compounding: Never interrupt it unnecessarily.”

The best way to beat most investors is to stay in the game longer than anybody.

Warren Buffet, one of the most popular investors of all time and founder of Berkshire Hathaway is said to have built his wealth through compounding. He has been consistently investing for almost a century.

Buffet started investing at age 10 and by the time he was 30, he had a net worth of over a million dollars.

At the age of 60, he was worth around $3 billion and by 66 he was worth $17 billion, which then grew to $32 billion by his 72nd and he is now worth over $123 billion at 92, meaning a $120 billion of his $123 billion net worth came after his 60th birthday.

Morgan Housel in his book ‘Psychology of Money’ said Buffett began serious investing when he was 10 years old. By the time he was 3o, he had a net worth of $1 million then.

“What if he was a more normal person, spending his teens and 2os exploring the world and finding his passion, and by age 3o his net worth was, say, $25,000? And let’s say he still went on to earn the extraordinary annual investment returns he’s been able to generate (22 percent annually), but quit investing and retired at age 6o to play golf and spend time with his grandkids,” Housel cited in the book.

Housel said that a rough estimate of Buffet’s net worth would be $ II.9 million which is 99.9 percent less than his actual net worth of $84.5 billion (as at the time of writing the book),

“Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years.

His skill is investing, but his secret is time. That’s how compounding works,” Housel said.

In the final part of this chapter, Housel said that good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated.

“It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period. That’s when compounding runs wild,” he said.