Com­pound­ing pro­duces spec­tac­u­lar re­sults, even at lower growth rates

Weekend Argus (Saturday Edition) - - FINANCE PERSONAL -

YOU’RE 30 and have 30 years to go be­fore your pro­jected re­tire­ment at 60. An ul­tra­rich benev­o­lent un­cle of­fers to fund your re­tire­ment in full. He gives you a choice:

• Op­tion 1: For each of your 30 years to go, he’ll as­sign to you R1 mil­lion, re­sult­ing in a hand­some lump sum of R30m in your bank ac­count on your 60th birth­day.

• Op­tion 2: He’ll as­sign to you 10 cents in the first year, and dou­ble it each year for the 30 years, so that in the se­cond year you’ll have 20c, in the third year 40c, and so on.

Which op­tion would you choose?

The R30m op­tion looks very ap­peal­ing, un­til you do the maths on Op­tion 2, which is 10c plus 10c mul­ti­plied by 2 to the power of 29 (which is 2 x 2 x 2 ... 29 times). This op­tion will give you R53 687 091.30, or over R23m more than Op­tion 1.

This is the marvel of ex­po­nen­tial growth or, more specif­i­cally in this case, com­pound in­ter­est, which Al­bert Ein­stein called the most pow­er­ful force in the uni­verse and the “eighth won­der of the world”.

Now no­body would ex­pect their in­vest­ment to dou­ble each year, which would be the equiv­a­lent of an an­nual re­turn of 100%, but, even at lower rates of growth, com­pound­ing pro­duces spec­tac­u­lar re­sults.

POS­I­TIVE EX­PE­RI­ENCE

A few weeks ago, I wrote a cou­ple of col­umns be­rat­ing the life as­sur­ance in­dus­try for their old-gen­er­a­tion in­vest­ment prod­ucts, quot­ing the poor re­turn I had re­ceived on a con­trac­tual re­tire­ment an­nu­ity I took out many years ago. I in­vited read­ers with pos­i­tive ex­pe­ri­ences of such in­vest­ments to write in.

I re­ceived quite a few emails from read­ers who had had neg­a­tive ex­pe­ri­ences, but I did re­ceive one pos­i­tive email, from Ian, a fi­nan­cial ad­viser, who wrote: “To be fair to the in­dus­try as a whole, I do think that you should oc­ca­sion­ally tell a good story, as con­tin­u­ally slat­ing the in­dus­try chases away young po­ten­tial in­vestors, who, cor­rectly ad­vised, can ben­e­fit from sound in­vest­ments.

“I quote two cases that I have re­cently had the plea­sure of ma­tur­ing:

• “The client took out an en­dow­ment with-profit on De­cem­ber 1, 1975 at R5 a month. There was no an­nual in­crease. To­tal con­tri­bu­tion: R2 520. To­tal pay­ment on ma­tu­rity: R219 512.81.

• “A sim­i­lar pol­icy was taken out Fe­bru­ary 1, 1978 at R23.46 a month. Again, there was no an­nual in­crease. To­tal con­tri­bu­tion:

R11 260.80. To­tal pay­ment on ma­tu­rity: R951 369.55.

“The point I’m try­ing to il­lus­trate is that, if you en­ter into a con­tract at an af­ford­able amount, and stay in the con­tract un­til ma­tu­rity, the power of com­pound in­ter­est is amaz­ing.

“I re­ally hope that you will also as­sist po­ten­tial clients by il­lus­trat­ing the pos­i­tives that can come out of long-term reg­u­lar sav­ing.”

Thank you, Ian, for those ex­am­ples of just how pow­er­ful com­pound in­ter­est is. And it is true that some peo­ple need the dis­ci­pline im­posed by a con­trac­tual in­vest­ment to put away money for the long term.

In­putting Ian’s fig­ures into the handy Per­sonal Fi­nance in­ter­est-on­sav­ings cal­cu­la­tor on our web­site (www.pers­fin.co.za), Client 1 achieved an aver­age an­nual re­turn of about 15%, af­ter costs, and

Client 2 achieved an aver­age re­turn of closer to 16%.

Not too shabby.

mar­tin.hesse@inl.co.za

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