Reaping The Rewards Of Compound Growth

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You often hear about the importance of time when it comes to investments, but it can be difficult to fully comprehend the rewards associated with compound growth. Compound interest allows you to earn interest today on the interest you earned yesterday and so on. This is known as exponential growth and can be neatly illustrated by the famous “rice on the chessboard” story:

An Indian king was very impressed by a new game called chess. He offered its inventor, a sage, any gift his heart desired. The sage made a modest and, seemingly, simple request: place one grain of rice on the first square of the chessboard and double it every successive square. The king agreed, ordered bags of rice, and began placing the grains on the squares according to the sage’s request, but soon realized he would not be able to keep his promise.  

Exponential growth was the problem. Upon reaching the 20th square he required 220 (just over a million) grains of rice. A chessboard has 64 squares, which means that the final square would have required 380 billion tons (at 48 grains/gram) of rice. That’s 500 times more than this year’s forecasted global rice production.

But how is this relevant to investing?

Consider the following investment strategies: In the year 2000, Investor 1 started investing US$1000/month in a balanced fund and contributed monthly till 2004, for a total of US$60000. Investor 1 then stopped the contributions, but left the  the money invested in the balanced fund till the end of 2014.

Starting in 2005, Investor 2 contributed US$1000/month, into the same balanced fund, and continued the contributions until the end of 2014, for a total of US$120000.

Investor 1 received a return of approximately US$250000 over the 14-year investment period (a total of US$310 000, including the original investement). Investor 2, on the other hand, received a return of about US$100 000 over their 10-year investment period (a total of US$220000). We see that Investor 1’s investment was worth 40% more than Investor 2’s, while having contributed 50% less. In fact, less than one quarter of Investor 1’s total came from contributions.

The key here, as with the story about the rice, is exponential growth: The base, from which future returns are earned, grows exponentially as an investment starts earning returns. This allowed Investor 1 to accumulate a fair amount of money by the time Investor 2 began investing.

You want to start investing, but when is the right time?

Global markets are fluctuating and various crises are unfolding across the globe. It can be an understandably confusing time for investors.  It’s impossible to make predictions about what will happen to the markets with any real accuracy. What we do know is that clients who’ve started early, leaving their investments to grow, have outperformed investors who put off investing in the hope that market conditions improve.

Do equity valuations concern you? Do you want to diversify asset classes, but you have no idea how? A solution unit trust, like a balanced fund, might be the answer you’re looking for. In a balanced fund, you allow an experienced fund manager to make the asset allocation and timing decisions for you. Either way keeping abreast of investment news will only help in this regard.

As many of us know, procrastination is our enemy. Market fluctuations typically even out over time, which rewards long-term investors. To truly benefit from the magic of compound growth, your money must spend time in the market.

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