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Tag: Compound Interest

The Boring Part of Finance That Will Build Your Wealth

Written by support@seostats.com on . Posted in Financial Planning, Goals, Investing, Saving.

Benjamin Franklin once said, “Money makes money. And the money that money makes, makes money.” That’s compound interest in a nutshell.

Now, before your eyes glaze over, hear me out. This is one financial concept you don’t want to ignore. Understanding compound interest can help you create true wealth, no matter who you are and how much money you earn now. It allows you to take a small investment, and over the years, turn it into millions. On the other hand, if you’re in debt, compound interest can make it harder to pay off your balance and find financial freedom.

It’s a fact: Compound interest is incredibly powerful. It’s interest that is calculated based on the principal (the original amount of the investment or loan) and the interest accrued during the previous periods. In other words, compound interest is “interest on interest.” This is in stark contrast to simple interest, which is calculated based on the original investment or loan amount.

 

An example: simple interest versus compound interest 

 

Simple interest:

Let’s say you invest $5,000 at 5% interest for 5 years. You can multiply the investment amount by the rate and time to get $250 in earned interest.

$1,000 x 0.05 x 5 = $1,250 in accrued interest

This means your investment will be $6,250 ($5,000 + $1,250) after 5 years.

 

Compound interest:

If you invest that same amount ($5,000) but use quarterly compounding interest, you’ll earn even more. Using an online compound interest calculator, you can see that your $5,000 will turn into 6,410.19 after 5 years of a 5% interest rate. That’s $160.19 more—just by using a compound interest rate instead of a simple interest rate.

Earning money over time is enough to get anyone excited, but there’s a lot more about compound interest that should perk your interest too. Here are 5 reasons we get enthused about compound interest and how it can impact your finances.

 

Reason #1: Anyone can benefit from it

It doesn’t matter who you are, where you’re from, how old you are, or even how much you’ve saved. Compound interest can work for anyone. Even if you start small, over time your savings will grow.

 

Reason#2: Compound interest can add up 

It often surprises our clients how compound interest accumulates in big ways. To explain, let’s look at an example.

Let’s say a 25-year-old person invests $10,000 in the stock market and earns an annual compound interest rate of 5%. According to the online compound interest calculator, the total value of this investment after 40 years is $73,584. More specifically, here are the earnings over time:

  • 20-years – $27,126
  • 25-years – $34,812
  • 30-years – $44.677
  • 35-years – $57,337
  • 40-years – $73,584

This data speaks for itself. The total value more than doubles over the last fifteen years, and almost triples over the second 20 years.

The best example of compound interest at work is Warren Buffet, who currently has a net worth of $81 billion. He credits his wealth to the power of compound interest. Most of his fortune was acquired after he turned 50, and he hit $70 billion in his mid-60s. Incredible, huh?

 

Reason #3: It isn’t about earning the highest returns  

With compound interest, you don’t always have to hit a home run with all of your investments. According to Morgan Housel, partner at The Collaborative Fund, behavioral finance expert, and former columnist at The Wall Street Journal, “good investing isn’t necessarily about earning the highest returns, because the highest returns tend to be one-off hits that can’t be repeated. It’s about earning pretty good returns that you can stick with and which can be repeated for the longest period of time. That’s when compounding runs wild.”

 

Reason #4: It can teach patience

It can take a long time for compound interest to pay off—many years actually. If you’re a person seeking fast cash, compound interest investing isn’t for you. It’s more of a slow and steady approach with the power to pay off big in the long haul.

 

Reason #5: It’s easy to understand and use

As I said, you don’t need an MBA or a finance degree to understand compound interest. It’s a relatively simple concept that anyone can use. That’s probably why credit card companies and lenders also rely on compound interest when using their funds.

This is the main downside to compound interest involves accruing debt that you owe. If you owe on your credit card and pay off the monthly minimum, your accumulated debt and a high interest rate can add up quickly over time. Compound interest and rates as high as 20% can really destroy your chances of building wealth.

Here’s the moral of the story: Start saving early to maximize the results of compound investing. Be patient because the big gains come later on. Just remember Warren Buffet, for example. He’s arguably the best example of how the power of compound interest can work in wealth.

If you’d like tips or need help creating an investment plan, talk to a member of our team today. We’re here to help you increase your wealth and can answer your questions about compound investing.

 

Lake Road Advisors, a Fee-Only, independent financial planning firm with offices in Corning, NY, Ithaca, NY and Portland, OR works with clients virtually all across the country. Paul Sydlansky, the founder of Lake Road Advisors LLC, has worked in the financial services industry for 20+ years. Prior to founding Lake Road Advisors, Paul worked at Morgan Stanley in Manhattan for 13 years. While at Morgan Stanley, Paul was a senior-level manager within the Institutional Equities Department. In 2018 he was named to Investopedia’s Top 100 Financial Advisors list. Paul received a Bachelor’s degree in Economics from Marist College and holds an MBA from New York University Leonard N. Stern School of Business. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN).

The Two Formative Experiences That Helped Me Grow as an Investor

Written by support@seostats.com on . Posted in Behavioral Finance, Education, Investing.

Who doesn’t like getting insights into the balance sheets and investment portfolios of other people – especially when those other people are successful professionals or financial experts?

CEO and co-founder of Ritholtz Wealth Management, Josh Brown, recently compiled a collection of exactly that in his book, How I Invest My Money, edited by Brian Portnoy and illustrated by New York Times’ columnist Carl Richards.

The book shines a light on 25 financial pros and how they use their own money to invest in capital markets. It’s a great look at how people who often give financial advice actually manage their own assets.

That inspired me to share my own strategy. I recently produced a video about how I invest my money. In telling my story and experience, I realized there were two specific events that helped shape the investor that I am today.

 

Developing My Current Investment Strategy Was a Process

Today, I invest for the long-term using a broad basket of ETFs that track broad market performance. I don’t try to time the market, and I don’t try to pick individual stocks.

Developing this investment strategy didn’t happen overnight. It took time to develop my personal investing style.

It also took two formative experiences that I can credit as the big reasons I am where I am today. In short, I learned the hard way why trading individual stocks is not the best way to grow wealth for the long-term.

 

My Investing Experience with Webvan

If you remember the early 2000s, you likely remember the dot-com bubble. A lot of investors felt overly confident in the futures of tech companies that were riding the wave of growing adoption of the internet and the spreading of personal computers in households all over the U.S.

I believed the hype; I was fully immersed in the boom and believed that it would never end. At the time, I worked as an analyst in Morgan Stanley’s Private Wealth Management division. It seemed like investors were simply printing money by jumping into IPOs.

Anyone could get rich by holding onto anything with a .com after its name. Of course, I wanted to do the same.

The company I got behind was Webvan Group, an online grocer that looked destined for success (but was, in reality, at least two decades before its time).

Webvan had an all-star management team and funding to back it up. At one point, its shares soared 65% over its initial offering price. And then they started to fall.

Justifying that this was just the stock going on sale, I bought in. And I kept buying. I bought shares at $15, $10, and $5. And I held them all the way to the company declaring bankruptcy.

 

Failing to Buy and Hold with Amazon

I made mistakes on the other side of the coin too. Instead of hopping into a bad bet and riding it to the bottom, I bet on a big winner… but didn’t stick around to see it pay off.

I bought shares of Amazon in 2012, when the share price was about $250. Over the next year, Amazon’s stock price shot up to over $300 a share.

I sold my shares in 2013, feeling pleased to get out before anything bad happened – and with a 20% profit to boot.

Fast forward to 2021 and we can clearly see that what seemed like a brilliant move at the time was actually a pretty terrible idea. Amazon now trades at around $3,000 per share.

That’s roughly 1100% higher than when I originally bought it!

 

What My Misadventures in Stock Picking Taught Me About Investment Strategy

These two stories illustrate a clear point: without the benefit of hindsight, it’s almost impossible to tell which individual stocks will turn out to be winners and which will go all the way to $0.

It’s easy to look back and laugh at my investment in Webvan. Clearly, that was doomed to fail as part of the dot-com bubble… right?

The truth is, that’s only obvious today. It’s easy to forget that Amazon was also an internet/tech company of that same era.

The problem with individual stocks is that you must know precisely when to buy. And that’s only half the equation. You also need to know exactly when to sell. Again, you can only know either, with certainty, when you look back with the benefit of hindsight.

This is why I no longer engage in the guessing games that individual stocks require you play. I also invest with intention and a plan, and don’t let emotions (like fear of a stock price dropping) make my decisions for me.

Instead, I rely on sound strategies based on my goals, time horizon, and risk tolerance. I combine those specifics about my own situation with experience and education about market history and new research and data that supports more passive, long-term approaches to investment management.

We use this same facts-based approach for our clients, too, to design investment strategies that meet their needs and take into account unique factors like their individual appetites for risk.

My process for investing will continue to evolve, but it won’t be influenced by randomness, chance, or emotions. Instead, we’ll continue to refine and hone our approach based on the facts and studies that highlight smart ways to grow wealth over time.

Understanding The Power of Compound Interest

Written by support@seostats.com on . Posted in Investing.

Compounding interest (or compound interest) is the most important concept in investing. Although acquiring a deep knowledge of investing would entail grasping hundreds of different financial concepts, a functional understanding of compound interest is the one thing that no investor can ever do without.

This post is designed to illustrate the following aspects of this all-important concept:

·What is compound interest and how it differs from simple interest

·The enormous benefits of allowing your investments to accrue compound interest for long periods of time

·How compound interest works against you in long term debt scenarios

 

The Difference Between Simple and Compound Interest

Put briefly, simple interest is interest that’s computed only on the principal, which is the original amount invested or loaned. You can compute simple interest by multiplying the principal by the interest rate and a given period of the loan or investment. Here’s an example of simple interest taken from Investopedia.

If you borrow $10,000 at 5% interest for 3 years, you would multiply these figures to arrive at a total of $1,500. Thus the total repayment cost of the loan would be $11,500.

Compound interest is interest that is computed on both the principal (the original amount of the investment or loan) AND the interest accrued during the previous periods. In other words, compound interest is “interest on interest.” The formula for calculating compound interest is this:

A = P (1 + r/n) (nt)

Unpacking this formula is beyond our scope, but by using an online compound interest calculator, we can see that $10,000 invested for 3 years at 5% compound interest will yield a total of $1,576.25.

This means that your total investment after three years will be worth $11,576.25, which is $76.25 higher than you would have earned (or paid) with simple interest. This represents an increase of approximately 5% compared to what you’d accrue with simple interest.

 

The Benefits of Compound Interest Over the Long Term

There is incredible power of compound interest you can unleash by investing a reasonable amount for about 40 years, as a retirement fund for instance. Let’s show an example of how powerful compound interest can be when you invest over the long term.

Let’s say that a 25-year-old person invests $10,000 in the stock market and earns an annual compound interest rate of 5%. Our online calculator (investor.gov) informs us that the total value of this investment after 40 years would be $73,584.17. If you examine this calculation more closely, you’ll see the enormous benefit of long-term investing.

Here are the total values of this same investment from years 20-40 in five-year increments.

20-year mark– $27,126

25-year mark– $34,812

30-year mark– $44.677

35-year mark– $57,337

40-year mark– $73,584

This data speaks for itself. The total value would more than double over the last fifteen years, and almost triples over the second 20 years.  Another way to look at it is you gain roughly $17k in the first 20 years on your investments while earning over $46k in the second 20 years. Hopefully, the moral of this story is abundantly clear– start saving early for maximum results and be patient as the big gains come later on. Just look at the likes of Warren Buffet, arguably one of the best examples of how the power of compound interest works. He credits his fortune with exercising this basic principal and still preaches it today. (MarketWatch)

 

The Downside of Compound Interest is Reserved for the Borrower

But there’s a significant downside to compound interest as well, at least when it’s accruing on a debt that you yourself owe. Just as financial institutions pay you compound interest for the temporary use of your money, lenders also charge you an often very costly rate for the usage of their funds.

It’s just as important to understand this negative aspect of compound interest as it is to be aware of its benefits. A little reflection will make the lesson of all this quite clear– invest for the long term, but be very aware of how carrying debt, such as credit card balances that have rates as high as 20%, can really destroy wealth. As simple as this sounds, it remains one of the essential keys to sound investing and economic security.