Invest 101 - Understand the Compounding Effect

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Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it.     -Albert Einstein-

No doubt, compounding is the strongest force in the world. To explain compounding effect in simple term, compounding effect = ability to generate earning using your capital + interest over time. 

E.g. if I able to achieve 100% growth every year, then the investment fund will be, 1k , 2k , 4k, 8k, 16k... over year.

Target for Consistency but not Super High Rate:

Key of Compounding effect is not high growth % but high consistency. Take Warren Buffett as example, his only achieve 26% growth every year. With this 26% annual growth, every 3 year, his net worth double up, then every 10 year, he append an additional zero to his net worth. So the key here is how many year we can consistently achieve the growth instead of the % of growth. 

Rule 72 in Compounding:

Rule 72 is a fast way to calculate how long you can double up your investment with X%. Example I target 15% annual growth, 72 / 15 = 4.8 - around 5 year, I can double up my total investment. Please take note this formula is for quick reference and not perfect.

Salary Man or Investor:

Let say a young graduate start working at age 24 with starting paid RM 3,000, then a consistent RM 500 increment every year. At age 55, he will get annual income RM 222k.
This young graduate also isolate RM 200 every month and invest it with target 8% gain per annual. At age 55, the investment income will be RM 322k.

When above example share, most of the people will go for salary-man instead of investor, because salary is recurring income that we can get and spend every month, but for compounding investment, our fund is locked there until age 54. 

But, why should we choose either one? Can't we do both? In example I share, every year, we just need to lock down Rm 200 per month, and target for 8% growth, then at age 54 we can achieve RM 322k. If that fund is unneeded at that time, we can continue the rolling.

Fine Tune version of Investor (Increment on Investment Fund):

Let take the same example , a salary man that will invest RM 200 per month with target 8% growth.
But this time, every year when I get my salary increment, I will increase monthly investment by RM 50, isolate RM 50 from RM 500 increment I think is doable. First year, RM 200 to RM 250, second year RM 250 to RM 300...until RM 1750 at age 54. 
At age of 54, we can achieve RM 1 million worth of investment fund.

Below are the chart comparison:

The above example is the path I working on now. As per today, every month I allocate RM 950 for investment purpose. Most of the time, the investment fund stay in Fix Deposit with low rate until I found a good investment that promise at least 8% growth only I will invest.

Don't use a Great Tool for small pocket money.