Wednesday, 5 August 2015

The Amazing Effects of Compounding

Many may not have heard of the power of compounding. Some may not even know how powerful it can be. Here, I shall revisit the effects of compounding to serve as a reminder for myself and those who are interested.


First we shall look at what happens when you Do Not Compound your money after an initial investment of $10,000 growing at 5% and 10% respectively (5 - 10% per annum is not hard).

Year
Capital
5% Return
Capital
10% Return
1
$10,000.00
$10,500.00
$10,000.00
$11,000.00
2
$10,500.00
$11,000.00
$11,000.00
$12,000.00
3
$11,000.00
$11,500.00
$12,000.00
$13,000.00
4
$11,500.00
$12,000.00
$13,000.00
$14,000.00
5
$12,000.00
$12,500.00
$14,000.00
$15,000.00
6
$12,500.00
$13,000.00
$15,000.00
$16,000.00
7
$13,000.00
$13,500.00
$16,000.00
$17,000.00
8
$13,500.00
$14,000.00
$17,000.00
$18,000.00
9
$14,000.00
$14,500.00
$18,000.00
$19,000.00
10
$14,500.00
$15,000.00
$19,000.00
$20,000.00
11
$15,000.00
$15,500.00
$20,000.00
$21,000.00
12
$15,500.00
$16,000.00
$21,000.00
$22,000.00
13
$16,000.00
$16,500.00
$22,000.00
$23,000.00
14
$16,500.00
$17,000.00
$23,000.00
$24,000.00
15
$17,000.00
$17,500.00
$24,000.00
$25,000.00
16
$17,500.00
$18,000.00
$25,000.00
$26,000.00
17
$18,000.00
$18,500.00
$26,000.00
$27,000.00
18
$18,500.00
$19,000.00
$27,000.00
$28,000.00
19
$19,000.00
$19,500.00
$28,000.00
$29,000.00
20
$19,500.00
$20,000.00
$29,000.00
$30,000.00

It takes 20 years to double the money if it is growing at 5%pa and takes 10 years to double if it is growing at 10%pa.

But take a look at what happens if you leave it to compound…


Year
Capital
5% Return
Capital
10% Return
1
$10,000.00
$10,500.00
$10,000.00
$11,000.00
2
$10,500.00
$11,025.00
$11,000.00
$12,100.00
3
$11,025.00
$11,576.25
$12,100.00
$13,310.00
4
$11,576.25
$12,155.06
$13,310.00
$14,641.00
5
$12,155.06
$12,762.82
$14,641.00
$16,105.10
6
$12,762.82
$13,400.96
$16,105.10
$17,715.61
7
$13,400.96
$14,071.00
$17,715.61
$19,487.17
8
$14,071.00
$14,774.55
$19,487.17
$21,435.89
9
$14,774.55
$15,513.28
$21,435.89
$23,579.48
10
$15,513.28
$16,288.95
$23,579.48
$25,937.42
11
$16,288.95
$17,103.39
$25,937.42
$28,531.17
12
$17,103.39
$17,958.56
$28,531.17
$31,384.28
13
$17,958.56
$18,856.49
$31,384.28
$34,522.71
14
$18,856.49
$19,799.32
$34,522.71
$37,974.98
15
$19,799.32
$20,789.28
$37,974.98
$41,772.48
16
$20,789.28
$21,828.75
$41,772.48
$45,949.73
17
$21,828.75
$22,920.18
$45,949.73
$50,544.70
18
$22,920.18
$24,066.19
$50,544.70
$55,599.17
19
$24,066.19
$25,269.50
$55,599.17
$61,159.09
20
$25,269.50
$26,532.98
$61,159.09
$67,275.00

It takes less than 15 years to double at 5%pa and less than 8 years to double at 10%pa.

Although it look close, do take note that this is only with an initial investment of $10k. You can do the following to boost the numbers significantly:
-          Make yearly injections (most easily achieved if you have the discipline to save regularly)
-          Increase the % returns (>12% could be quite hard for most people)

That being said, the earlier you start, the better it compounds. Below is a website link which is very informative and the chart is easy to understand.
 


Investing Wolf 
Disclaimer: This is not a recommendation to buy or sell any mentioned stocks or securities in this blog. 


6 comments:

  1. Hi,

    I think it's easy to get 5% returns per yr but it's not easy to get 5% compounded returns per yr. Looks really good on paper but in reality can be a bitch :/

    ReplyDelete
    Replies
    1. Hi LP,

      Yea i agree. That's why I concentrate on what i can do today to improve my % and worry about other things later. To be honest, it is dependent on the instruments, knowledge and application involved to be able to generate consistent returns year after year.

      Delete
  2. Investing Wolf,

    I can understand where you are coming from.

    You have not had a down year yet. Hence that scenario is "foreign" to you.

    Youth, your strength is you don't know what cannot be done ;)

    So don't let anyone rain on your parade!


    OK, now no sugar-coating ;)

    Your straight line extrapolation on the effects of compounding may apply better on CPF Special Account ;)

    Once you've experienced a down year, you'll know first hand how that messes up the effects of compounding. As far as I know, no well known trader or investor never had a down year :(

    Just a gentle reminder NOT to let that moment (when it happens) go to waste. Record down your epiphany!
    Listen to your own voice.

    Up till now, I see you have drawn your inspiration from outside in - Rich Dad Poor Dad, Dividends Warrior, books you have read from the library, Business Insider; etc.

    You'll know you have moved on to the next phase as a veteran in the markets is when you switch to: This is what I Investing Wolf says ;)

    And you'll understand that when veterans say its better to start early, what they meant is the sooner you blowup your account or have a big down year, the quicker our REAL journey of self discovery starts!

    ReplyDelete
    Replies
    1. Hi SMOL

      First and foremost, thank you for leaving a comment :D

      Second, I feel CPFSA is an account which, although has the higher interest on the 1st 40k, is something we will not get to enjoy even till we die (because of the minimum sum and withdrawal scheme) unless they change the rules (in fact, i doubt my loved ones will get to use it either).

      Third, I'm hoping not to have a down year because the instrument that i chose should make money whether the market goes up or down (unless i become crazy, start doing reckless trades, not closing when my stop is hit or attempting a home run and fail terribly). In fact, it may not even be affected by the general markets (unless we stop using oil, natural gas, gold or other commodities which is highly impossible).

      Fourth, this blog exist to document my progress and journey since i starting on options. Hence, even if it is a very bad month, i will still post monthly (unless i am physically unable). Hopefully, it can inspire more comments or advice from good folks like you and investors/traders-to-be.

      In Russian there is an expression: The wise man learns from someone else’s mistakes, the smart man learns from his own, and the stupid one never learns. My reason for joining this community of bloggers is so that i could learn from the experiences of everyone and at the same time preventing myself from making a huge loss of capital that i can ill afford to suffer.

      "Rule No.1 is never lose money. Rule No.2 is never forget rule number one." - Warren Buffett is my motto... and fortunately for me, although i lost some money in nearly every month, i could make it up because of the way my contracts are staggered across a few months (except for those losses in Oct 14 and Jul 15 which were huge because i was greedy and complacent).

      Thank you once again for visiting my blog and giving me your valuable advice.

      Delete
    2. investing wolf,

      I like your answer!

      I'll come back again ;)

      Bloggers without conviction in what they say, or crumble at the first poke/challenge, what's the point again? LOL!

      I'm always seeking good grindstones to whom I can sharpen my saw against. And that starts with a different opinion ;)

      Options on futures?

      You young people are making me feel my age...

      Delete
    3. Haha... SMOL

      Yea... I was counting on you to come back and share more advice so we can learn more :PP

      I always love a challenge. I believe that only with challenges to our thinking can we truly learn valuable lessons and come up with innovative answers/solutions. 8X

      I also believe different beliefs are what is necessary for most of the things in life. Imagine if we all share the same belief, then nothing new would appear. If the Wright brothers did not have a belief that we can fly, we would not have airplanes now.

      Options on Futures is a combination of options contract on the futures market. Basically the fundamentals are similiar to Stock Options but applying it to Futures would allow me a higher premium for a near similiar amount of margin and more diversity than the stock market.

      You can read more about options selling from my previous post: http://tinyurl.com/optionsselling And when i am more free i would come up with another post on how selling options really work on the market.

      Haha... Learning never stops no matter what right.

      Delete