Investing Myth 4 | The Simple Interest Myth | I want returns Every Month
The Seven Investing myths continues. Our next myth is ‘The Simple Interest Myth: I want returns every month’.
Previously, we had The Savings, Stock Market and Ponzi myths, Go check them out, they would be worth it.
Investing is not salary income. It is not a monthly stipend. It is not pocket money. No, this is a misconception that runs deep in not a few unsuspecting investors. The moment you begin to see it as either of those, it blindsides the power of compound effect.
In school, we were taught Simple Interest and Compound Interest.
What is the difference again?
Simple Interest Vs Compound Interest
Simple interest is defined as Principal multiplied by Rate multiplied by Time divided by 100. And it returns every year or every month as the case maybe. Therefore by simple interest, you earn a single/simple return on your investment every month. And you take that interest out, probably to spend it. And leave the principal amount which gives you same interest again next month.
However, with Compound Interest, you reinvest the principal (plus interest) again at the same rate and within the same time, continuously.
Compound Interest is just simple interest that has a longer (read the word, LONGER) time period more principal and more interest to invest.
Bear with me, I would explain.
In simple interest, the duration is mostly for the short term, one year or less.
In compound interest, however, the duration is always for the long term. Say 5 years, 10 years or 50 years.
And the principal, well it increases every time the interest on the Simple interest is earned.
So while in simple interest, the interest is set aside and principal reinvested. In compound interest, however, the interest is added back to the principal and that principal plus interest is reinvested.
That simple logic, illustration or principle is the most important secret to building wealth. Compounding Interest.
If you earn returns every month, you are Simple Interest-ing,
When you are Simple Interest-ing, you are a short-term thinker. It doesn’t really amount to much on the long term. Plus your capital depletes beacause of inflation.
On the other side however, If you earn and reinvest. Earn and reinvest. And continue that circle. You would see that little interest, reinvested compound to much over the long term.
When you are compounding, you are a long-term thinker. It does become a snowball.
When in doubt, Ask WarrenBuffet.
A Little Lesson on Compounding
We take a cursory journey back the memory lane using the annual list of the richest men in America as a case study. The Forbes list of the richest men in America has been on since 1982. And we take a look at two men who entered the list just one year apart from each other.
- Mr Buffet entered the list in 1986 while Mr Gates’s first entry was in 1987.
- In 1987, Bill Gates, 31 at 1.25b USD was the 31st richest person in America while
Warren Buffet, 57 was the 9th richest at 2.1b USD.
- 1n 1993, Gates was No 12 at 6.7b USD while Buffet was 13 at 6.4b USD.
- In 1999, Gates was No 1 at 90b USD while Buffet was No 2 at 36b USD.
- In 2015, Gates was No 1 at 76b USD while Buffet was No at 62b USD.
Mr Buffet compounded his wealth by investing in companies. Mr Gates compounded his wealth by building a technology company.
What lessons ?
- Build a Noah’s Ark early in Life. Something you can do for 100 years and not grow weary. For Gates, it was Microsoft, for Buffet, it was Berkshire Hathaway.
With the power of compounding, they have both stayed in the top five of the wealthiest in America since 1995.
- When others are losing their head, stay on your Game. Both Messrs Buffet and Gates still hold a considerable stake in their companies.
- Dont seek to be the first, in business, being the Best makes richer. Mr Gates wasn’t the first to do computers, but in the 80s, 90s, he was the best. Mr Buffet wasn’t the first in picking stocks, he learnt from Ben Graham, but he did it better than no one.
- The Only way to compound wealth is by compounding it. Messrs Gates and Buffet rarely lived ostentatious lives. They know that every spend of their dollar limits the ability to compound the return down the line.
- Until you find something you would do till you die, you have not found a way to make a billion. Yes, you can make a million working, but when you find something that feels like a hobby, you have a higher chance of zigging and zagging onto the billionaire mark. Mr Buffet tap dances to work. Mr Gates still checks in with the code guys at Microsoft.
A One NIght Stand or A Generation?
When an individual invests in the market and wants a monthly return, two people are in trouble.
The one giving the return and the one receiving the return. The one giving the return would make decisions for the short term that would see the account deplete in value. And the one receiving the return would be earning unsustainable returns that would not stand the test of time, the friend of the one who compounds.
Honestly, if you want a monthly return, consider your operations (let’s not call it investing) as a meal ticket, pocket money or salary.
But then why dont you just go get a job? A job offers better odds of sustainability.
But to be a serious investor, like Mr Buffet, begin to compound your wealth for the long haul. You would be amazed at how the ‘holy-grail’ of wealth looks so easy. That’s a long shot, but, you have a greater chance returning as a billionaire than simply earning interest monthly.
See, it is entirely impossible to build wealth over the long term operating on a simple interest mindset. That’s not how wealth works. That is the short term myth.
Real wealth is built by operating on the long-term based on compound interest.
Simple interest is akin to a one-night stand. The pleasure is in the duration, short and non-committal.
Compound interest is like getting married. Then having kids, who have kids and build a generation.
You go through the ebb and the flow. But you have a legacy.
Mr Buffet started reading about Investing at age 8 and made his first investment at 12. Mr Gates began advanced programming at Age 13.
Begin Investing early, but Compound your Interest.
The conclusion of the matter is:
Start Early. Invest Early. Compound For the Long Haul. And don’t forget to have Fun.
5 min read.