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Great Guy

Compound Interest - Eighth Wonder of the World

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The great Albert Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”.

 A few threads have mentioned compound interest. At the risk of sounding a nerd I find it amazing how compound interest "works".

Imagine saving £100 a month and earning 5% a year on this money. At the end of 10 years you have invested £12k and your investment is worth £15,592. At twenty years the figures are £24k and £41,274. At thirty years £36k and £83,572. At forty years £48k and £153,237. You can see in the early years your investment is basically only worth what you have put in, but later on compound interest really works it's magic.

I find it amazing how a relatively trivial sum of money adds up into something fairly substantial. Someone in their twenties could relatively easily save £100 a month and retire early....

PS The UK stockmarket has returned 5% a year in real terms, on average, over the last century.

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Yup.  It should be compulsory in schools.  Also how debt interest accumulates even more rapidly.

Realised this in the first year of my accounts training when we got to the section about investments and started working some figures about long term equity returns compared to inflation; looked at tax avoidance methods in the tax modules so that an increasing income stream didn't come with an increasing tax bill and I have done it ever since.

However eventually coming to the realisation that there is a lot more to life than just accumulated tax free investments is why I am still choosing to work in my early fifties.

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15 minutes ago, goldbug9999 said:

All great except for the fact that inflation is also compounding.

The U.K. stockmarket has returned 5% after inflation on average a year.

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Overpaying a mortgage can reap the same dividens even I will have saved around 8.4k in interest payments If i clear it by November which will mean it’s taken 7 years to clear .the interest is now down to 15 quid a month the first month it was 100 quid ok I admit I’ve been aided by interest rate cuts from 4.1 down to 2.4%

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4 hours ago, Great Guy said:

The great Albert Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”.

 

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

~ John Maynard Keynes
 
It depends what you are saving money for. If you save a currency, you will be subject to it's inflation. Just hope that the interest will outpace it. 
 
 

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3 minutes ago, Happy Renting said:

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

~ John Maynard Keynes
 
It depends what you are saving money for. If you save a currency, you will be subject to it's inflation. Just hope that the interest will outpace it.
 
 

It rarely, if ever does though.

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2 minutes ago, Dave Bloke said:
5 hours ago, Great Guy said:

The great Albert Einstein once said “Naughty, naughty, very naughty.

 

Eezer good'un.

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1 hour ago, Mirror Mirror said:

It rarely, if ever does though.

No.  In the last twenty years I've only been in cash deposits once and that was twenty k so hardly big bucks.  This was into one year bonds because I'd just packed in a job and if I decided to take an extended break (or if it was forced upon me!) then I had enough ready cash for a year but would need a refill after that.

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For me this is the best screenshot about compounding, but I will attach a story (made up).

Felicity is 23 and the government says her retiremnent age is going to be 68.

Now Felicity is a sensible girl and decides to tuck away $50 per week into a savings/investment/pension that guarantees a minimum return of 6% (I told you this was a story).

Anyway, foolishly she neglects to change the payment but does it regularly (not sex) for 45 years.

In the end she has?

291311410_Screenshot-2019-5-4MoneycalculatorPresentandfuturevalues-MSNMoney.thumb.png.e2d1691514e76e230c86ea0b85d382b3.png

The interesting bit of the graph is in green as it starts to go expo.

https://www.msn.com/en-us/money/tools/timevalueofmoney

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Posted (edited)

I’m going to piss on this a bit with a miserable truth.  Compound interest doesn’t really do anything for the first 20 years - you only end up with about 13% more money than if you only received interest on the original invested amount.  However after 40 years you are about 50% better off.  What is my point?

Well if you have not really saved much by your 40’s then you will not really benefit from compound interest for retirement saving (interest yes, just not compound).  On the other hand if you sacrifice and save a fair bit during your 20’s and 30’s then you will coin it on those prior savings during your 40’s, 50’s and 60’s, ahead of retirement.

The pension bores aren’t kidding when they say start early kids.

Edited by GARCH

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Barclays have done research on the long term results of cash/ bonds/ shares.....

This is genuinely interesting. Over the last 120 years cash has been a poor investment. Bonds not much better. But shares..... Wow!

£100 to £35,000 in 120 years.... Before anyone asks, that after inflation.

Remember this when someone says shares are risky.

 

 

image.png

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3 hours ago, Mirror Mirror said:

It rarely, if ever does though.

https://www.xe.com/currencycharts/?from=GBP&to=CHF&view=10Y

32 minutes ago, Great Guy said:

Barclays have done research on the long term results of cash/ bonds/ shares.....

This is genuinely interesting. Over the last 120 years cash has been a poor investment. Bonds not much better. But shares..... Wow!

£100 to £35,000 in 120 years.... Before anyone asks, that after inflation.

Remember this when someone says shares are risky.

 

 

image.png

Two issues with that.

Survivor bias for equity - 120 years ago equity barely existed.

 

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3 minutes ago, spygirl said:

Two issues with that.

Survivor bias for equity - 120 years ago equity barely existed.

 

Fair enough point. Someone investing in other stockmarkets (like Russia and China) might not have done well either.

However the graph does show that the stockmarket can produce fairly decent long term returns. 

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1 hour ago, GARCH said:

I’m going to piss on this a bit with a miserable truth.  Compound interest doesn’t really do anything for the first 20 years - you only end up with about 13% more money than if you only received interest on the original invested amount.  However after 40 years you are about 50% better off.  What is my point?

Well if you have not really saved much by your 40’s then you will not really benefit from compound interest for retirement saving (interest yes, just not compound).  On the other hand if you sacrifice and save a fair bit during your 20’s and 30’s then you will coin it on those prior savings during your 40’s, 50’s and 60’s, ahead of retirement.

The pension bores aren’t kidding when they say start early kids.

That is exactly correct, the first 20 years are hard going and demoralising, that’s why Felicity had to shag it out for 45 years.

The returns are dismal until total cumulative interest equals total investment.

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4 hours ago, GARCH said:

Well if you have not really saved much by your 40’s then you will not really benefit from compound interest for retirement saving (interest yes, just not compound). 

Bugger.

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6 hours ago, Chewing Grass said:

For me this is the best screenshot about compounding, but I will attach a story (made up).

Felicity is 23 and the government says her retiremnent age is going to be 68.

Now Felicity is a sensible girl and decides to tuck away $50 per week into a savings/investment/pension that guarantees a minimum return of 6% (I told you this was a story).

Anyway, foolishly she neglects to change the payment but does it regularly (not sex) for 45 years.

In the end she has?

291311410_Screenshot-2019-5-4MoneycalculatorPresentandfuturevalues-MSNMoney.thumb.png.e2d1691514e76e230c86ea0b85d382b3.png

The interesting bit of the graph is in green as it starts to go expo.

https://www.msn.com/en-us/money/tools/timevalueofmoney

How old is Felicity, and do you have her phone number?

Also, does she take it up the *****er (could be a deal breaker)?

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12 hours ago, GARCH said:

I’m going to piss on this a bit with a miserable truth.  Compound interest doesn’t really do anything for the first 20 years - you only end up with about 13% more money than if you only received interest on the original invested amount.  However after 40 years you are about 50% better off.  What is my point?

Well if you have not really saved much by your 40’s then you will not really benefit from compound interest for retirement saving (interest yes, just not compound).  On the other hand if you sacrifice and save a fair bit during your 20’s and 30’s then you will coin it on those prior savings during your 40’s, 50’s and 60’s, ahead of retirement.

The pension bores aren’t kidding when they say start early kids.

Yes then watch a woman walk off with 50 % of it 30 years later

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