COMPOUND INTEREST: THE $ WONDER OF THE WORLD
by Dexter S. Aoki
The “tortoise”or “slow and steady wins the race” philosophy of investing has always been a hard sell for
much of the investing public. “The 8 Mutual Funds to Buy for 2005” blares the popular financial publication on
its front cover! “Ten Stocks Under $15” counters its competitor in even bolder print! One of the sad truths in
investing is that the public has a short memory and time does indeed “heal all wounds.” You don’t hear as many of
the financial pundits commenting on the 2000-2002 bear market these days. Witness the excitement engendered by
the internet company Google when launched in late 2004.
For most people, compounding, or the deliberate mathematical process of allowing ones money to
multiply, is the tried and true path to wealth creation. Albert Einstein claimed that compounding was the greatest
mathematical discovery of all time.
There are two ways to earn interest on your money - through simple or compound interest. Simple
interest is the rate of interest applied only to the principal, which is the amount originally invested. For example,
5% a year on a $100 investment results in a total of $105 after the first year, $110 after the second year, and so on. Compound interest applies interest to the principal amount as well as to any accumulated re-invested interest.
For example, 5% on $100 compounded results in $105 the first year, $110.25 the second year and so on. It seems
boring until you consider a little history. Peter Minuit purchased Manhattan from the Indians for $24 worth of
trinkets in 1626. Today, the value of Manhattan is of course in the billions of dollars. Now consider that same
$24 compounded at 5% from 1626 to the present. It comes to 2.4 trillion dollars! Using the 70 year New York
Stock Exchange market average return of 10%, the amount reaches a mind boggling 106 trillion dollars!
An Index is a portfolio of specific securities (common examples are S&P, DJIA, NASDAQ), the
performance of which is often used as a benchmark in judging the relative performance of certain asset classes.
Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance is not
indicative of future results.
Figures quoted are for illustrative purposes only and are not necessarily indicative of past or future results
of any specific investment. they do not include consideration of the time value of money, inflation, fluctuation in
the principal of, in many instances, taxes.
An important lesson to glean from this concept of compounding is the danger of the reverse or having it
work against you, i.e. credit card interest or mortgage interest coupled with stagnant or declining real estate
values.
Mr. Macawber in Charles Dickens’ David Copperfield put it best, “Annual income twenty pounds, annual
expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty
pounds ought and six, result misery.” To avoid a sad financial outcome, it may help to remember the two rules of
investing:
- Rule 1 - Don’t lose money.
- Rule 2 - Remember rule one.
Since time is critical in the compounding process, financial representatives always stress the need to start
early when investing. It is also important to remember that although what you earn is important, anything that reduces
that return such as overspending diminishes the benefit that compounding can provide. Today’s advertising blitzes
make this difficult. So in closing, don’t be afraid to be a “Tortoise Investor” and avoid “Hare-brained” investment
schemes.
Securities offered through Royal Alliance Associates, Inc., Member NASD, SIPC. Investment Advisory Services offered through WealthCare Financial Services of Hawaii, LLC |
