The Magic of Compounding is Everywhere

January 04, 2021 | Elaine Law


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Looking at 'compound investing' in yourself

Traditionally, people may have learned about the power of compounding from investing in fixed income. Let’s say you bought a GIC that pays you 2% on $10,000 of capital. At the end of the first year, you would receive your $10,000 principal back plus interest of $200 for total proceeds of $10,200. After the second year, your interest is compounded based on $10,200 which will provide more income than the first year. This time, the 2% interest rate return would earn $204 and generate a new total of $10,404. This exercise of compounding is presumably extended for many years, thereby illustrating that a portfolio can rise exponentially over time.

By the same token, compounding also works for dividend-paying stocks and income funds. For example, a balanced income fund or a dividend stock may pay around 4% in distributions. If you add the 4% to your original investment of $10,000, you will have $400 worth of distributions in your first year. Using that $400 to buy extra shares or more units of the fund will also have an exponential compounding effect on your account size over time.

The magic of compounding also works for growth stocks and growth funds. Similar to the above examples, compounding works faster the greater the return profile. In all cases, when returns are accrued on top of previous years’ returns, the investment can grow rapidly. In general, the “rule of 72” tells an investor how many years it takes to double your investment based on an expected annualized return. Historically, since 1945, the S&P500 has averaged 7.2% per annum. Therefore, if one expects a 7.2% annualized return, it would only take 10 years for your investment to double (ie. 72 / 7.2 = 10yrs). Ultimately though, the magic of compounding takes time. Working with a trusted advisor to navigate through the market’s unpredictable volatility and to help maintain a level of patience is one way to turn the magic of compounding into a reality.

As the New Year begins, it’s often a time we speak of New Year's resolutions. I think we can apply the power of compounding not only in terms of investments, but also in our daily lives. Start with small, good habits and watch the effects of these small habits compound to potentially life-changing benefits. Here’s a list of the things that I have personally tried that I would like to take an opportunity to share:

  • If you are right-handed, start writing with your left hand or use your mouse with your left hand or brush your teeth with your left hand. This can help stimulate the parts of your brain that you don’t usually use.
  • Add easy short exercises throughout the day, e.g. when you wash your hands, change your clothes, or when you wake up you can do some squats, push-ups or jumping jacks for 1 minute!
  • No time for reading? Try audio books and listen to them when you brush your teeth, cook your meals, do your laundry, etc…. You will be amazed at how much you can learn.
  • Learn something completely new - perhaps a new language, or a musical instrument – I have learned how to code, and I call myself an aspiring web developer. Your mind will open up and you will learn to appreciate things a lot more.
  • Eat less sugar and perhaps less frequently –  some studies show that this can sharpen your mind and improve your mood. It worked for me!
  • Tap into your subconscious mind – your subconscious mind is much more powerful than your conscious mind. Listen to positive/gratitude affirmations for just 10 mins while you sleep, twice a day. This has changed my life!

Have a Happy, Prosperous, and Healthy New Year. May all good things compound in your lives!