The Power of Compounding Interest. Making RM 1,000 into RM 1,000,000 / by aqeel ungku

Written by Rondy Yunanda (@Ryunanda in Stockbit)

The not so secret investment tool

In this blog post, I will be sharing a “not so secret investment lesson” that probably everyone would and should have known. I’m talking about compounding interest. For those who are new to the investment world, compounding interest is basically just interest stacked on interest. Compounding helps your money grow exponentially as the interest earned is continually 'added' to the 'base' amount. This new net amount will then be the amount that interest rate will be calculated against. This forms a continuous cycle that will allow you to earn an ever increasing net amount of money!

Compounding is probably the most powerful investment tool ever. To illustrate this, assuming that I can offer you a 100% interest everyday on your investment. An initial RM 1,000 investment will become RM 2,000 investment on the second day, RM 4,000 on the third day, and… RM 1,000,000 on the twelfth day!

Of course the illustration above is unrealistic and way too good to be true. Currently, the best FD rate offered is 4.6% return per annum (year) and yes, while that interest rate feels like a bummer, everyone, yup, everyone can still be a millionaire through good saving habits and compounding interest.

The most important ally to compounding interest, apart from the rate of return (“interest”) are:

1) Time and

2) A good habit of allocating monthly savings to invest for the future

Do you know that you can become a millionaire after 35 years by saving RM 1,000 monthly in a risk - free fixed deposit paying 4.6% interest per annum If however, instead of investing in this relatively  lower yielding fixed deposit, you are to invest in an asset class that yields an average 20% interest per annum - you would have made your first million after only 16 years.. and made RM 36 million within 35 years!

The biggest takeaway therefore, is that a small difference in return can make a big difference in wealth in the long run.

es.JPG

Investing in the stock market

This brings us to the next question - how can we increase the rate of return on our investments? Well, investing in the stock market is definitely one of the method of making that difference in returns. Stock market is deemed by many as “risky” and while that notion is not wrong, it is definitely one that can be argued.

Historically speaking, there is a high probability that long term investments in stocks will yield positive returns. For instance, if you compare the performances of any blue chip stocks in the KLSE / KLCI index over the past 10 years, approximately 90% will yield a positive return! Sure, there are some blue chip stocks that had lost its value over this period and can no longer be categorized as a blue chip. This scenario however, is uncommon.  Furthermore, if you happen to invest in the right company like Nestle, you could be looking at about 500% return. Do you also know that if you had invested in America’s S&P 500 index (an index that constitute 500 largest stocks in America) 10 years ago, you would have earned  an annualised 22.5% return? (you can do this via ETF but that’s a topic for another day!)

Time is therefore the most loyal partner to investors and the stock market is one of the most powerful investment instruments to gain compounding profits in the long run. Today's investors are blessed with a variety of support that ease their investment processes, thus allowing them to be able to begin investing early on in life. The difficult part is just to start this good habit! Last and foremost, investing in the stock market is a long term process - you will need time to learn and gain experiences to eventually be able to make sound investment decisions.

fd.JPG

 

Summary

In summary, compounding is a very powerful tool for wealth creation. Diligent investment in the stock market is a method to increase the rate of return / compounding on your profit, and it is important to start early with good investment habits to maximise this potential.

Reference

1) check out our fellow stockbitor's (@mengteck) video on compounding interest, very insightful! https://www.facebook.com/savwee.my/videos/1715154898715548/

2) Interest calculator - https://www.msn.com/en-us/money/tools/timevalueofmoney