Time is money - the magic of compound interest
“Investing should be more like watching paint dry or watching grass grow.
If you want excitement, take $800 and go to Las Vegas.” Paul Samuelson
Firstly, in order to even contemplate carrying out a successful Escape Plan, you obviously need the financial resources in place to pull it off i.e. the moola, the spondoolies, the dollar, the bacon, whatever you want to call it - the money.
Rob Berger was on the right track when he famously quoted “The best thing money can buy is financial freedom”.
Hopefully, after subscribing, and receiving Part One of The Escape Plan 'Don't spend it like Beckham' you are now thinking a bit more about your spending and maybe even applying some of the cost cutting strategies. If you don't have any spare capital at the end of each month this is a vital step. Unless you can get yourself to the stage where you're not spending all you earn you will never get an Escape Plan up and running. Once you're past this hurdle, however small a sum it is at first, we can start thinking about investing now at least have some money left over each month to think about investing.
Now let’s have a look at when and what we should be investing in.
Time is money - the magic of compound interest
So, when should we all start investing?
A very simple question, with a very simple answer. Ideally today, or now (or yesterday if you’re Dr. Who).
Everybody knows the answer to this one, but how many people do it or find the time to even think about doing it? As frequently stated in Part One of The Escape Plan, the problem with modern consumerism is that the internet has made it far too easy to get instant gratification from a purchase, which makes taking time out to invest in your long-term future seem quite tedious and boring. Who wants to spend time putting £100 into an equity ISA when you can click a button and receive a pair of killer heels the next day (or is that just me?).
Unfortunately, the endorphin release you get from the purchase is addictive and habit forming. But as everyone who does it knows, the feeling is normally short-lived and you quite often experience guilt or a lull afterwards. The only way to break this bad spending cycle is to force yourself into a good routine – something I will mention time and again throughout this blog in various guises.
HOT TIP: Set up a monthly direct debit paying £100 a month into a savings or ISA account on the day you get paid. If the money is not in your account, you will not spend it (hopefully!).
So, returning to why we should be investing today. Let’s go back to high school and remember the teacher droning on to a bunch of uninterested eleven-year-olds about compound interest. Little did we know at the time that this concept is one of the most powerful and financially lucrative lessons we will ever be taught.
Albert Einstein was once quoted as saying “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t pays it. Compound interest is the most powerful force in the Universe.” Big words from a clever chap - I certainly wish I’d paid a bit more attention in the lesson and to Albert – I only truly grasped how positive and useful it is in my late twenties. For those of you who were asleep in that lesson, or checking out the fit guy/girl on the back row, compound interest is the addition of interest to the principal sum of a loan or a deposit. In layman’s language, it’s interest on interest.
Now if you’re only invested for a couple of years, this is neither interesting nor exciting. Invest over the long-term, and it becomes a whole different matter. Like an out of control snowball gathering in size, the sort of returns it will provide will make even the cynical, negative, can't-be-arsed nay-sayer sit up and take notice.
For example, using a 6% return rate (which is the approximate long-term historical stock market return rate) if Sally invested £361.04 every month from the age of 20, she would have a retirement fund of £1million by the age of 65. That’s from an outlay of just £194,961.60.
Poor old Barry, aged 45, would have to save £2,153.54 a month to obtain a £1million pound fund at the same age.
Figure 1: How much you need to save each month to get to £1 Million at retirement (6% return)
Hopefully this example gives you an understanding of how powerful this snowballing effect can be over long periods of time, and also highlights the benefits of starting early. If you can’t start saving and investing twenty-five years ago, the second best option is to start today. Remember, even Barry amassed a £1million over 20 years from total savings of just over £500,000.
The problem is people get put off by doing anything over long time periods. This breeds inertia and another year passes whereby you have done zilch to secure your future. But if you break it down to whatever you can afford, set up your direct debit so that it becomes part of your financial routine, it becomes achievable.
Another excuse that people give me for sitting on their hands, is that they are now too old to start. Or ‘Wishnertia’ as I call it. “I wish I had started investing twenty years ago” or “Good idea – I just wish I had met you twenty years earlier”. As far as I am concerned, it’s never too late to plan for the future. After all, we’re all living a lot longer these days.
In the words of LaoTzu “A journey of a thousand miles begins with a single step...”
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