The Power of Compounding

1
The Power of Compounding
2
Compounding creates new money..

• What new money is created on 5000,
• if 8 is earned?
• 5000 (1 0.08) 5400
• 5000 400
• Original Lump Sum New Money

3
What about next year?

• What new money is created on 5400,
• if 8 is earned?
• 5400 (1 0.08) 5832
• 832
• 5000
• Original Lump Sum 400 432
• (Yr 1) (Yr 2)

4
Where are we in five years?

• 5000 ( 1 0.08) 5400
• 5400 ( 1 0.08) 5832
• 5832 ( 1 0.08) 6298
• 6298 ( 1 0.08) 6802
• 6298 ( 1 0.08) 7346

5
How long will it take to double my money?

• Rule of 72
• 72 How many years it takes
• Interest Rate to double your money
• 72 9 years
• 8

6
Is there a faster way to work it out than this?

• 5000 ( 1 0.08) 5400
• 5400 ( 1 0.08) 5832
• 5832 ( 1 0.08) 6298
• 6298 ( 1 0.08) 6802
• 6802 ( 1 0.08) 7346
• .

7
Yes!

• no of years
• Principal (1 interest rate/100)
• (One plus the interest rate)
• to the power of
• (the number of years)
• multiplied by (the principal)

8
Example where are we in five years?

• The long way
• 6802 ( 1 0.08) 7346
• The short way
• 5000 (1.08)5 7346

9
How does this apply to real life?

• Take a person who starts saving 3000 per year
  from the ago of 22. She puts away the money into
  a high interest account earning 6
• How much does she have when she turns 65?
• 674,186.99!!!

10
Could you put a price on Manhattan?

• In 1626, the natives in New York traded Manhattan
  for 24 worth of glass beads.
• Do you think that was a good deal?
• Who got the better deal?

11
Who got the better deal?

• If the Americans had put that 24 on deposit at
  6 interest in 1626
• They could buy Manhattan today
• TWICE OVER
• SKYSCRAPERS AND ALL
• AND have 1 billion left over in spare change

12
Now, think about how the expenses impact

• Transaction Costs
• and
• Taxes

13
Remember the lady that put away 3000 per year

• Imagine, if each year, 5 of her portfolio was
  taken away in transaction costs.
• By the time she would have arrived to 65, 5 of
  the portfolio was worth
• 674,186.99 5 33709

14
What if you could reduce that to 1?674,186.99
1 6741
15
What is her saving?

• 26968
• The price of a VERY NICE new car

16
Taxes

• Currently, the government charge 25 of any gains
  over and above 1270.
• The impact of transaction costs is enough to
  prove to you the difference expenses can make
  over time
• What if you could legally avoid paying tax?

17
How do you avoid paying tax on your gains
legally?

• Put the money into a pension!
• All a pension does is put a wrapper around your
  investments that prevents the tax office from
  taking some out of it.
• Also, it stops you from going on a spending
  spree, as it is tied up there until you retire

18
Are they not just for the elderly?

• Not at all, instead of spending all your money
  now, you simply put some away, let it grow and
  live more comfortably and enjoy life all the more
  when you do retire.

19
The Point Is To Start As Soon As You Can
20
In real life

• Carry out these three exercises to find the
  answers using the short cut formula.
• no of years
• Principal (1 interest rate/100)