The power of compounding

Albert Einstein once said, “Compound interest is the eighth wonder of the world”.

Compound interest arises when your current sum of money earns a specific interest in the first year and the total amount obtained at the end of the year is allowed to compound for a specific period without removing the entire sum. The earlier you start, the more the money works for you and gets compounded.

If you invest $3600 every year for 25 years at 12% per annum return (this return can be achieved by investing in the stock market and choosing your stocks wisely), you get $480,001 at the end of the 25th year. But if you procrastinate just 1 year, the same $3600 invested every year for 12%p.a. return, gives you only $425,359 at the end of the 24th year. You can see that by delaying a year, we have lost $54,642 in future value. Thus, it has been advocated by a lot of people who-have-been-there-done-that to start saving and investing early starting from your first paycheck. Strive to set aside at least 10% or more of your monthly income for savings and investments and see your money grow. Becoming financially secure and free is not that hard after all, if you know what to do.

Investing is the best way to make your money compound. Investing is essential as by putting money in the bank, a paltry interest rate of around 0.1% per annum (p.a.) is given but the average inflation rate in Singapore is around 2.7% p.a. So, by depositing money in the bank, we are actually losing 2.6% p.a. Therefore, we should all learn to invest in a instrument that beats inflation.

Another advantage of investing is that it gives you passive income. Income is divided into two categories: Active and passive. Active income is income you get from your daily 8-to-5 job. By working, you are trading your time for money and there is only so much a person can work each day. Passive income is income you get while not working. Example, from dividends, rental income, royalties and businesses, among others. Thus, one needs to have multiple streams of income. During the financial crisis in 2007, top executives lost their jobs as they were getting expensive to be paid. People who worked for 40 years in the company and some who were directors were retrenched and were helpless. Relying on your salary is the worst thing you can do to yourself and your loved ones as job security is non-existent nowadays.

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