The Eighth Wonder of the World
The 7 natural wonders of the world include the Aurora Borealis, the Harbor of Rio de Janeiro, Grand Canyon, Great Barrier Reef, Mount Everest, Paricutin and Victoria Falls.
Albert Einstein was on to the power of compound interest. He called it the “Eighth wonder of the world”
“Compound interest is the eighth wonder of the world. He who understands it, earns it…. he who doesn’t…… pays it.
Compound interest is the most powerful force in the universe.
Compound interest is the greatest mathematical discovery of all time.” – Albert Einstein
Compound interest is like double chocolate topping for your savings. You earn interest on the money you deposit, and on the interest you have already made. You can earn interest on your interest!
An online savings account that pays monthly interest is an example of an account that earns compound interest. Compound interest is different to simple interest. With simple interest, interest is only paid at the end of a specified term. A term deposit is an example of an account that will earn simple interest and not compound interest.
The compounding of returns is a powerful factor, which is constantly at work for financial portfolios that are property structured, take a long-term view and are well managed.
Let’s have a look at an example of compound interest at work –
You may be saving for your first home, children’s education, a family holiday, early retirement, a bigger family home or a new car. No matter what your goal is or why you are saving the biggest tip we can provide you is start today! Don’t wait till tomorrow because tomorrow never comes!
Let’s assume you have $10,000 and you can save $200 per month for the next 10 years. If you were to receive an average return of 8% per annum every year you would have $58,786. Your initial deposit and regular deposit equals $34,000 over the 10 year period. This means that with the power of investment returns and compound interest your gain is $24,786.
The amount of your return will depend on the risk you are prepared to take and your timeframe.
Rule of 72 – In finance, the rule of 72 is a method of estimating an investments doubling time. The number 72 is divided by the interest percentage per period to obtain the approximate number of periods required for doubling. so if you are getting an 8% return it will take 9 years to double your money (72 divided by 8 = 9). If you were to increase your risk and get a 10% return you would double your money in 7.2 years.
There are many different investment options available including cash, fixed interest, property and shares.
Investments that pay interest are quite often seen as safe investments. But some types of interest bearing deposits may not be as safe as you think. What you are really doing is lending your money to a company or institution and in return you get interest payments from them. The easiest and safest example is a term deposit with a bank or building society. Cash is generally used when you want to park your money for a short time, money you need for emergencies or at call, for your short term goals or to reduce the risk in your investment portfolio.
Cash and fixed income will give you an income return but no capital growth to protect you from inflation. So if you invest $10,000 today you will get your $10,000 back at the end of the term. If you have a long term horizon you should consider protecting yourself against inflation.
Buying a property to rent out is a popular form of investment. Houses and units are easier to understand than other types of investments, yet they do have some issues you need to be aware of.
Here are some of the benefits –
- Property can be less volatile that shares or other investments
- You can earn rental income and benefit from capital growth (if your property increases in value over time)
- If you take out a loan to purchase an Investment Property, interest on the loan and most property expenses can be offset against your rental income, for tax purposes
- You can see and touch it
But with the benefits come some pitfalls –
- Rental income may not be enough to pay your mortgage
- If interest rates increase your repayments will increase and you will need to fund the extra loan repayments
- There may be periods of time when you don’t have a tenant and you will have to cover all the costs yourself
- You can’t sell the bathroom if you need to access cash in a hurry
- The value of the property will go up and down over time
- The entry and exit costs can be high with costs such as stamp duty, legal fees, building and pest inspections and real estate fees.
The benefits of investing in shares are
- Potential capital gains from owning an asset that can grow in value over time.
- Potential income from dividends
- Lower tax rates on long term capital gains.
With the benefits of investing in good quality shares there are risks you should also be aware of. For example if the share price falls and you sell the share you will lose part of your capital. The value of your shares will go up and down from month to month and the dividend may vary. It is really important to do your research on the companies you are investing in. Choosing shares to buy and sell requires time, research and analysis. However if you are willing to put in the time and keep an eye on the market and economy, building a share portfolio can be very rewarding. Buying shares is a good way to build your wealth over time and as with other investments shares are not without their risks. Think carefully about your options and seek financial advice from a Certified Financial Planner.
In summary, we agree with Albert Einstein that compound interest is the eighth wonder of the world and can help you achieve your long term financial goals. There is allot to consider when planning your future and what investment options are available to you.
Phil is a Certified Financial Planner with over 10 years’ experience helping every day Australians achieve their dreams and goals.
Please call us on 1300 153 251 if we can help you become financially fit! We would love to talk to you.
Have a sensational week.