Einstein's advice on how to earn money with the eighth wonder of the world
| 15.07.2021
| 3 minutes of reading
How can Einstein's genius help your money?
According to Einstein, compound interest is the eighth wonder of the world. As he said, “He, who understands it, earns it…He, who doesn't…pays it.” Maybe it sounds exaggerated but when you count, you find out it's not.
Everyone who has ever had a mortgage loan knows that the longer he pays, the higher extra sum is paid on interests. That's because we pay interest for a large part of the sum more times. However, the same effect can be seen with investments but it helps increase wealth in this case. Most often it's called compound interest but some financial columnists call it the eighth wonder of the world. And rightly so.
Let's start with a simple example. Let's suppose that we have invested into a mixed fund for 3 years. The monthly report states that our fund has increased exactly by 5 % each year. What is the overall yield? You may already guess that it is not 5 % + 5 % + 5 % = 15 %. The overall yield is 15.8 %. Why?
We have invested in this fund EUR 1,000. Our investment will be worth EUR 1,000* after the first year (1 + 5 %) = EUR 1,050. Next year, it's not only our initial investment that's capitalised but also our gain from the first year – the investment value at the end of the second year is EUR 1,050 * (1 + 5 %) = EUR 1,102. Similarly, after the third year the investment value is EUR 1,102* (1 + 5 %) = EUR 1,157.6. In addition, the overall yield is EUR 1,157.6 / EUR 1,000 -1 = 15.8 %. That's the effect of compound interest, i.e. interests on the already obtained interests (or yields in the world of investments).
First feature of compound interest:
The actual capitalisation is mostly higher than a simple count of the annual investment yields.
The 0.8 % difference between the simple count of the annual capitalisations and the correct count of compound interest in the previous example was approximately EUR 8. It's not too much. However, what will be the effect after 10 years?
Simple count of ten 5 % capitalisations is 50 % but the actual growth of the invested money is 63 %. The 13 % difference from the invested sum is yet significant.
Second feature of compound interest:
The longer the investment capitalisation lasts, the greater the positive effect of interests on interests will be.
Let's move from examples to reality. Imagine that we have invested EUR 1,000 in the American equity fundTB at the end of 2009. Annual yields were as follows:
|
Annual assessment of the American Equity FundTB |
|
|
2020 |
2,5 % |
|
2019 |
28,7 % |
|
2018 |
-2,8 % |
|
2017 |
6,9 % |
|
2016 |
13,5 % |
|
2015 |
6,9 % |
|
2014 |
25,7 % |
|
2013 |
28,2 % |
|
2012 |
9,9 % |
|
2011 |
6,6 % |
|
2010 |
21,2 % |
If we count these yields, we will have a result of 147 %. Nice! However, we already know that our EUR 1,000 hasn't grown to EUR 1,000* (1 + 147 %) = EUR 2,471. The actual capitalisation was 280 % and our investment has the value of EUR 1,000* (1 + 280 %) = EUR 3,801. That's a huge difference indeed.
Third feature of compound interest:
The higher the investment yields are, the greater the effect of interests on interests will be.
What does it mean for our investments?
Compound interest can significantly help fulfil our long-term goals. If we believe that shares will continue bringing long-term results at the level of 5 % - 10 % per year, we should also consider the great help of the effect of interests on interests and make the most of it.
How to utilise this effect? Open the Investment savingTB for the American equity fundTB simply, via Tatra banka mobile aplication.
Disclaimer
The investment in a mutual fund is connected with risk and the yield until this day provides no guarantee of future yields. Both the value of a mutual fund investment and the yield thereon may increase and decrease and a shareholder may not get back the entire invested sum. The by-laws, selling prospectus and key information for the mutual fund investors are available in Slovak language version at Tatra banka, a.s. branches. As much as 100% of the value of assets in a mutual fund can be invested in the transferrable securities and financial market instruments issued or guaranteed by a member state of the European Union. The official name of the mutual fund: Tatra Asset Management, správ. spol., a. s., Americký akciový fond o.p.f.
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