Interest Rates: Taking Aim at Compounding

By | June 5, 2007

Ever since I was a kid, my parents used to tell me how important saving in the bank was. But I never got it. I understood that the bank would pay me something called interest in return for looking after my money for a while. Little did I realize that their definition of ‘looking after’ included re-lending the money to others 10x over and earning high rates of interest, but repaying smaller rates for a risk that I was taking.

Anyway, I never really got enthusiastic about rates of 1% or 2%. As a kid, I could never be enthusiastic about getting an extra dollar or two per year from my savings account. As an adult, I’m kind of still suspicious of compounding not because it doesn’t work, indeed it does! But I’m very suspicious of how the Mutual Fund industry, the Pensions Industry, etc., have all made us acutely aware of the value of compounding to the extent that we’ve had huge bull runs in stock prices in the last 20 years.

Millions and millions of investors, thousands and thousands of companies, and dozens of countries are all saving like crazy for a rainy day by buying and selling stocks, etc.. But the risk is increasing, as bigger and bigger gambles are taken. It’s like driving fast, soon you begin to wonder if you’re moving at all! All the other cars are moving that quickly, too, that it looks like everyone is parked! You know the sensation I mean! But isn’t it time you slowed down, you looked around, and you started to reconsider the speed and, more importantly, the direction of your financial car!?

Investors have become so intensely focused on future growth prospects with high rates of return, that they are being persuaded to pay higher fees, costs and taxes on their investments, while completely forgetting that they are being rewarded for their investments, not today, not tomorrow, not next year in many cases, but at some definite but usually far away point in time when the mistakes of today have been covered over by the magic of compounding.

One of the reasons that I am no longer so interested in investing for the future is that I am much more interested in what I can do with the money TODAY. I don’t mean that I want to spend it, but I’m becoming more focused on ways I can utilize the money I have today to become more tomorrow. So, purchasing an asset might be a wise investment; but splashing it out on a car that isn’t an antique Bentley is not.

Another reason is simply: risk. We are all reminded again and again:

A thousand dollars socked away when you’re 20 and growing at 10 percent per year will be almost $73,000 when you’re 65. The same sum saved when you’re 50 will grow to $4,200 at age 65. That’s a stunning truth that should compel any young person to start saving early — and the rest of us to start right now. (see Compounding at Yahoo! Finance).

Of course, the assumption is that you will get 10% on average every year or a little more some years and less others. BUT, as many investors know from the Bubble/Bust years, it’s quite possible to walk away with NOTHING. Yes, NOTHING. I lost over 50% of the value of some stocks from my own portfolio between 2000 and 2002. I was lucky. Others lost much more. The bust affected individual holders as well as mutual fund holders who invested in Tech. In fact, even diversified portfolios took a hit. There are times that stocks do badly, and not just a little badly, they can take a real drubbing!

Some solutions offer themselves, such as ETFs, with their low management fees, etc., but again, that means people are still socking away money for the future. Most ETFs are very new, and are untested in troubled times. It’s not unreasonable to conjecture that ETFs could go flounder, just as Mutual Funds did. Other solutions may be viable depending on your skillset, orientation towards money, and amount of time, such as Options Contracts, Currencies, etc..

But for my own situation, I am now creating a highly personal solution by trying to find as many ways to generate surplus cash as I can. I’m not so fussy right now about the particular ways or indeed how much income they generate as long as it is more than $0, but as my confidence grows, so will my variety and experience. Somehow, having the cash in my hand from work that I have done seems much more of a sign of a promise kept, than a hope outstanding.

Right now, therefore, I have the following income streams:

1. interest on some money in the bank
2. dividends on some stocks;
3. profits (albeit small)  from a business;
4. income generated by this blog – posts, links, etc..
5. income generated by selling my services – teaching and consulting;
6. and a salary.

I’m also exploring renting our current living space and parking space, but I haven’t persuaded my wife that it makes sense! I’m quite sure that I shouldn’t put all my eggs in one basket, esp. #6. But I don’t have enough time to find other streams right now!

What streams of income did you find? How many do you have? Do you have a plan to become independently wealthy? Let’s hear it here!

Author: InvestorBlogger

Investorblogger.com takes you on a 'Random Walk To Wealth' through money, investing, blogging and tech. We'll explore my insights, mistakes, and experiences together.