Читать книгу Ignore the Hype - Brian Perry - Страница 29

The difference between asset class performance and investor performance comes about as a result of timing issues – namely, many people are getting in and out of sectors and markets at the wrong time, and all too often buying high and selling low. Moving in and out of the market and spending too much time on the sidelines prevents an investor from leveraging the most powerful tool at their disposal.

But what exactly is compound interest? Well, let's say you invest $10,000. One year later you've earned 10% on your investment, or $1,000. Now assume that in year two you also earn 10% on your investment. Have you earned another $1,000? No. You have in fact earned $1,100, because you earned 10% not only on your original $10,000 investment, but also on the $1,000 worth of gains you'd achieved in the prior year. (Please note that 10% annual returns year after year would be exceptional. I've selected that number simply for ease of math.)

This pattern would continue indefinitely; if in year three you again earned 10%, your dollar gain would come out to $1,210. Over longer periods of time, this compounding factor can produce truly immense gains.

In 10 years, $10,000 grows to $25,937

In 15 years, $10,000 grows to $41,772

In 20 years, $10,000 grows to $67,274

In 30 years, $10,000 grows to $174,494

In 50 years, $10,000 grows to $1,173,908

Figure 2.4 Growth of $10,000 with 10% Annual Returns

SOURCE: Analysis by Brian Perry.

For instance, using the initial $10,000 investment from the preceding example and assuming 10% annual returns, Figure 2.4 shows what your growth would look like.

As you can see, while the percentage returns remain consistent, wealth accumulates exponentially. That ability to convert small initial investments into vast sums reflects the power of compound interest.

That power in turn leads to a couple of important truths when it comes to organizing your finances.

First of all, time is your friend. The sooner you begin investing, the more likely you are to build wealth. In the earlier example, someone who had invested $10,000 shortly after graduating college would have accumulated more than $1,000,000 by their early 70s.

The second important takeaway is that compounding works in both directions. That same power that can build your wealth can also destroy it, if you allow yourself to become saddled with too much debt. The compounding effect of credit card, student loan, and other consumer debt can make it virtually impossible for some people to dig their way out.

The final takeaway is that, given that financial markets tend to go up more often than they decline, staying invested is vitally important. In other words, an investor needs to remain invested in order for compound interest to work its magic.

As we'll discuss in the remainder of this chapter, staying invested is something many individuals struggle to do. But for those who succeed, the rewards can be vast.