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.

Quick Lesson: What the Rich Does, and the Rest Don't (part 2: Gambling?)

One important factor that the rich sets themselves from normal investors, is the way the rich look at investing.

Normal investors have to understand that investing in shares should never be exciting. Define exciting? When you find yourself sitting infront of the live price stream, and find a drop of 2% too much to handle, such that it makes you want to look at the price stream, hoping for more buyers than sellers.

If you are staring at the charts cause of contra trades, you are gambling.

In the past, with me holding shares of companies that have made +30% (and still holding), I no longer feel the thrill of the shares increasing in price. In the search for thrill, I made the mistake of finding excitment by doing contra on large movers. Maybe initially I'm able to make money, but gains were in the range of $100-$500 dollars, but losses were larger due to the large commission charges. In the end, I see my +30% gain in my portfolio become something more like 20% due to contra losses I made.

I can safely bet (and its a calculated gamble here) that 90% of successful investors never do contra. The gains from contra trading is too insignificant for the amount of time staring at the charts, and sleepless nights cause its T+2 already. If you were to hold on to good stocks, chances are 50% PA returns are very easily achievable. Together with compounding returns, you will see your $10,000 become $50,000 in no time. Try doing that in contra trading.

Quick Lesson: What the Rich Does, and the Rest Don't (part 1)

Many people around me always whine about how the rich seem to get richer, and the poor just stays poor. And when I'm talking about poor people, I don't just mean families or individuals that make less than $20,000 a year.

First of all, what makes an individual wealthy? By the car they drive? House? Monthly expenditure? You've got to understand, even if you make $5000 a month, but you squander away all that money within that month on luxury stuff, you might appear wealthy, but in fact you are not. Here is why.

Most wealthy have the ability to put aside a large proportion of their income to investment. Most of us don't. The wealthy have the ability to to that due to their large income. Many of us can't due to our small pay check. And even when we get a raise, we would just increase our monthly expenditure, and that includes our year end bonuses.

"The rich get richer cause they know how to spend their bonus and pay raise, not on material gains, but in investments."

Most of the wealthy people reinvest their investment returns. Most of us don't. Many of my peers make $1000 from their $10,000 shares, and immediately sell and splurge on a holiday or a material gains. They remain that "10,000-dollar-air". You should reinvest to enjoy compounded returns.

"Spending your profits in shares really leave you standing in Square 1"

The fact of the matter is, if you are interested in trading in shares, and you are here reading my blog, really means you have that spare cash (that you really don't need) to invest! So ask yourself, why do you need to spend the cash that you made on your investments?! Isn't it better for you to reinvest those gains, for larger absolute gains next time? Yes I do understand the need to enjoy yourself. My guide is not to use more than 10% of your gain on celebration.

"The fact of the matter is that if you are reading my blog, you probably have the spare cash that you don't ever need to use to invest. So stay vested."

So to answer the question, the ricch have the ability to not only make their capital grow, they know how to make their investment returns grow as well.

Over the next week, I'll be talking about "compounded interests" and several other things that the rich do, but the rest don't.