There is one statement that has been attributed to Albert Einstein:
"Compound interest is the eighth wonder of the world".
Whether this is correctly quoted by the man himself is arguable, but what is correct is that the magic of compounding is essential for retirement planning.
Ask Warren Buffet, probably the greatest investor in this
lifetime as demonstrated by his management of Berkshire Hathaway. He describes
the power of compound interest as building a little snowball and rolling it
down a very long hill. As the snowball rolls down the hill, it collects more
and more snow until it becomes a huge snowball. At an annual shareholders’
meeting, Buffett gave this answer to question on how to make billions, “The
trick is to have a very long hill, which means either starting very young or
living… to be very old.”
Compounding, in its most basic terms, is just a repetitive
process that can magnify gains in the long term. As what Warren has said, the
longer the duration, the better.
Take for instance A and B who both decided to invest $500
per month for 8 years, with the same interest rate of 3% interest, not super
high by today’s standard. A started investing at age 22 while B decided to “eat, drink
and be happy” in his earlier years and start his investing journey at age 52. When they
both reach 60, there is a stark difference. A would have accumulated over $131K
while B would have just $54K! The only difference is the timing.
So, what would be a good way to start this journey
- Identify the basic amount…perhaps start with $5K in a S&P500 low-cost fund
- Add a recurring monthly investment of perhaps $500 to $1K
- Continue for 10 years, 20 years or more...
- See the magic happen!
Obviously, when we have more funds to invest (when we
get promoted or salary increase), we can add more to the fund. Alternatively, when we have more knowledge, we go on a different path with the same
principles but with Global funds, Energy, Finance companies, etc.