Difference between not investing, getting simple interest and compound interest
(Image Source: http://ponderingmoney.com/2009/10/12/you-need-to-understand-compound-interest/)
What is compounding anyway? It seems like one of the buzzwords coming from the ever-so-fashionable financial sector, just like retirement and wealth management. Compounding is when the interest or return that you have earned is added back into the principle and continues to earn a return on it. For example, $1000 growing at a 10% compounded rate of return annually would have grown to $1100 at the end of the first year (no difference to simple interest yet), then $1210 ($1100 * 110%) then $1311. This is different from simple interest where the amount that you get annually is the same as the interest is not reinvested. So, $1000 growing at a 10% simple interest would grow to $1100 at the end of the first year, $1200 at the end of the second year and then $1300.
Though in the short-term (3 years in the example), it does not have a large difference, however all this adds up and as seen in the graph above, as time goes on, money grown with compound interest grows exponentially while money earning interest no compounding (simple interest) grows at a constant rate and this makes a larger difference as time goes along. Of course, the worse would be not investing the principle and getting no return at all which would be the straight line portion of the graph.
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Besides cpf or bank acct, which invesrment vehicle provide compund interest?
ReplyDeleteI would say none is as effective as the theory example that is shown.
Shares does not compound. They merely rises as business grow and will fall too. Thus is capital gains.
Dividends reinvestment is subjected to rise and fall of price.
There is no compounding effect.
The 1 with real compound effect with soso rate is cpf. But it comes with risk as policies concerning cpf can be implemented anytime which could be negative with our long term plans
Hi Rokawa,
DeleteI think that bonds, like the Singapore Government Bonds or the new Singapore Savings bonds, even retail bonds traded on the SGX, allow us to reinvest our dividend income into them, by buying more bonds.
Shares, though subjected to the rise and fall of prices, can also be compounded using dividends, just need to reinvest it regularly, something like dollar-cost averaging, except that the amount is not fixed. Or we can hold on to our dividends to buy when the market is down, but then we need to see if the price drop would compensate us sufficiently for the compounding effect that we have lost.
Thanks for your comment :)
From,
Just Some Thoughts
Hi guys,
Delete1) Although there are many company that provide dividends, there are only so many companies that provide constant and increasing dividends throughout the years (at least >10 years). It is up to us to look for them and buy either at a lower price (usually when market falls) or DCA (which was mentioned).
2) If you depend on CPF or SSB, you can expect your money to be worth less in the future due to inflation. That's why there are a lot of investors who are looking for >5% dividend yields from stable companies.
3) If you depend on the banks, you might as well just sleep on your money. Unless your bank provides >2.5% interest then refer to point 2.
Happy Investing
InvestingWolf
Hi InvestingWolf,
DeleteYes, we should be looking towards companies that pay good dividend yields consistently, or another way is for us to invest in companies that reinvest their profits instead of paying out dividends, but that seems to be a contentious issue as investors like Benjamin Graham would rather receive dividends as covered in his book The Intelligent Investor.
Thanks for your insightful comment
From,
Just Some Thoughts
Hi JST,
DeleteFirst, I see myself on your sidebar :) (Thanks for indicating I'm an interesting read :P).
Second, it depends on the kind of investor you are looking to become. Investors can be generally be considered into 2 groups: 1) Dividend and/or 2) Capital Appreciation. Most of the bloggers you see online are type 1 with a minority being type 2. Rarer still are those who apply both. After all, who doesn't like extra income every few months?
InvestingWolf
Hi InvestingWolf,
DeleteThanks for noticing the addition :)
I agree that most bloggers look for dividends, but I think that's mostly important when you are retiring and would like to receive payouts to fund your retirement. For me, I don't mind my returns coming from either capital appreciation or dividends, it's still money in the pocket. (Of course, assuming that the company is still able to earn good returns on equity to justify the extra investment).
From,
Just Some Thoughts
Hi JST,
DeleteYea. But when you are young, and with the stock market on it's 6th year bull run, you would most probably concentrate on capital appreciation. I believe only when the market presents an opportunity then investing in companies with appropriate dividend would make sense.
Also, when dividends come in, it is quite passive. When in it for capital appreciation, we need to look out for change in trends, etc. I would consider it more active than dividend.
InvestingWolf
Hi InvestingWolf,
DeleteAgreed, think that we should look for dividends mainly when the market presents good opportunities like in the last recession.
From,
Just Some Thoughts