Lack of patience, more than anything else, hamstrings investors in their pursuit of profits. I wrote in July 2004 that impatiently trading in and out of equities with no eye toward compound interest will bring investors everlasting sorrow.
Compound Interest and You
Here’s a compound interest story that should help you and your spouse. Let’s assume a hypothetical $10,000 investment with a 7% annual return for 20 years. Investor A draws the 7% ($700) each year for living expenses. At the end of 20 years, the original $10,000 in capital remains in place, and $14,000 in simple interest has been drawn for living expenses. The end value in capital and interest drawn is $24,000. Now let’s assume hypothetical Investor B invests the same $10,000 at the same 7%, but draws nothing and simply let’s the money compound for 20 years. Well, $10,000 compounded at 7% for 20 years has an end value of $38,696. You will see that $14,696 ($28,696 – $14,000) represents interest on interest. Over half of the long-term total return for Investor B reflects interest on interest. Unfortunately, compound interest is not a concept that is well understood by most investors.
To their everlasting sorrow, most investors not only lack a basic knowledge of compound interest, but also lack patience and dividend/interest religion. Many are greedy, trade way too often, and are in debt. For the record, I have no debt. I buy for cash. I have never employed margin and tend to own the investments I make for a long, long time.
Retired and soon to be retired investors should place their confidence in the unmatched power of compound interest.
Originally posted on Young’s World Money Forecast.
Latest posts by Dick Young (see all)
- How to Build 37% of Your Wealth in Just Ten Days - September 20, 2019
- This Decision Could Lead You to Financial Disaster - September 18, 2019
- Witness the Raw Power of Diversification - September 13, 2019