Quick Lesson: What the Rich Does, and the Rest Don't (part 3: Compounded Interest)

It was in an article I read recently, that when asked what was the most powerful math formula known to him, Einstein said it was "Compounded Interest". Indeed.

The basic idea is simple. For every return in terms of capital gain and dividends, you reinvest them, to see exponential growth.

Lets say you have $10,000 to begin with. And assuming a return of 25% PA on your best investment (25% is achievable easily in Unit Trusts, so its conservative). You do not spend the returns on food or car. Calculated on a monthly basis, here is what the $10,000 would look like.

• 2 Years - $16,403
• 3 Years - $21,007
• 5 Years - $34,458
• 10 Years - $118,736
• 15 Years - $409,140

Time to buy the SLK you always wanted. But on the other hand, if you find yourself there with this kind of success, you'll not spend that money as just another 5 years. This is what you get if you didn't buy the SLK.

• 20 Years - $1,409,815

So, still want to buy your SLK?

Maybe spending your $1,000 profit in Sino-Env wasn't such a good idea? Though its tempting, I recommend buying shares on the notion that the returns are not "spendable".

So does that mean that after buying Share A and seeing a 100% return, I've got to sell it to see the compounded interest grow itself?

That was what I thought. But recently, I've got this revelation in my sleep.

Lets say you bought Sino-Env when it was $0.50. A few months later, you see it at $1.00. Thats a 100% return. A few months later, at $1.50, thats a 100% return from $1, but a 200% from your capital. From $1.5, to $3, thats a 100% return from $1.5, but a 600% return from your $0.50.

A $0.1 gain from $3 is about 3%. But from your purchase price of $0.5, its 20%. Need i say more?

Thats the beauty of compounded interest. Hold off that champagne to 20 years from now, where the champagne is 0.00001% of your gains, rather than 10% of your gains.