Compound interest rewards patience in an impatient world

Compound interest – its impact is truly miraculous. For over 30 years I have been writing and speaking about its power, but do you understand it?

It is slow to start: not much happens in the first years. But that’s life – anything worthwhile takes time. This applies to getting in shape, losing weight, improving your sport or starting a business.

Accept that success takes time

In his book Atomic Habits, James Clear speaks of the “plateau of latent potential”. He compares the tray to a species of bamboo, which spends its first five years building extensive root systems underground, before shooting 90 feet in the air for six weeks. Just because sometimes it takes longer than we would like to see the results of our efforts doesn’t mean our efforts will be in vain.

In fact, most of the important work – hoarding – won’t seem to amount to anything, but of course it does.

Any goal we have will take time and effort to accomplish and starting it will probably be more difficult than finishing it. But you have to keep going, because habits and hard work add up.

Epictetus tells the story of Lampis, the shipowner, who, when asked how he acquired his great wealth, replied: “My great wealth was acquired without difficulty, but my little wealth, my first gains, with much of work”. Yet the average human being is wired for quick results. This is why many who start an investment program (or fitness, dietary change, sports or business program) give up at first. They are discouraged by what they see as a lack of progress.

Just be patient and consistent

So in composition you have to wait to see the results. Your small, consistent efforts, if you are patient and consistent, will reap big rewards. But the other most important factor that determines how fast your money grows is the rate of return you get. The combination of time and a good rate of return turns small sums into a small fortune.

Over Christmas I was delighted to receive an email from a woman I first met as a customer in 1991, 30 years ago. Beryl is now 88 years old and the $20,000 I invested for her in January 1991 in the Advance Imputation Fund is now worth just over $700,000. The fund was managed by legendary investor Robert Maple-Brown until his death in 2012.

The numbers are fascinating. If we go to the stock market calculator on my website, we see that $20,000 invested in the ordinary accumulation index in January 1991 would now be worth $337,000. That’s a return of 10.23% per year, which is excellent by anyone’s standard. However, Beryl’s fund clearly beat the index. If we run the numbers using my compound interest calculator, we find that a return of 12.6% per year would take $20,000 to $700,000 in 30 years. This 2.37% difference in rate of return nearly doubled Beryl’s money over the 30 years.

Why did I compare its returns to the All Ordinaries Index? Because the index is accessible to all investors, regardless of their financial knowledge, and there is no need to pick winners. About 20% of actively managed funds outperform the index over the long term. The Catch-22 is 80% not beating the index after taking fees into account.

Thus, the problem for investors is to find the best performing funds. The obvious solution is to consult a good advisor for advice on funds that suit both your goals and your risk profile. Good advice costs up front, but in the long run it costs nothing – it pays off.

But financial success is about more than choosing the right selection of managed funds. Beryl’s husband is now 94 and they have a large sum of money coming out of an interest-bearing account that is due in about a month. She was also seeking information from me on what to do with the money that was coming due.

Financial planning options

After a long discussion, I pointed out that at their life stage, ease of management is key. Since their investments are already well diversified for their age and they have no chance of getting the old age pension, they could simply let the equity trust continue to accumulate and draw down money in the bank. Hopefully, the stock trust will grow faster than their money in the bank would shrink. They might also consider disbursing funds to family members as soon as possible, updating their wills, and/or increasing charitable donations.

Beryl then revealed that they had eight grandchildren at different stages of their lives. Some are good money managers, and some are at the other end of the spectrum. This caused them serious concern.

This is where additional guidance is essential. There will be a large unrealized capital gain on the shares, which could be mitigated if their wills are written so that the managed funds go to the grandchildren who intend to keep the funds intact. Testamentary trusts are also an option.

I recommended that Beryl and her husband speak to an estate planning attorney and involve both their accountant and a financial adviser in drafting their will in a way that is both tax efficient and fair.

Thanks to compound interest, this couple is faced with one of the best problems for any investor: how to best use and bestow a lot of money. I concluded our phone conversation by reminding him of the Chinese proverb: “The best cashews come when the teeth are too old to chew.

Noel Whittaker is the author of Making Money Made Simple and many other personal finance books. [email protected] This article is general information and does not take into account the situation of an investor.

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