February 18, 2021 / Insight from Ksenia Lee, BA, CFP®, Wealth Advisor
My mother taught me a lot about money when I was growing up. She was the first person who talked to me about interest, and how investing my money could make me more money. I was fascinated by this idea. To my knowledge, parents of my friends did not have those conversations with their daughters, and now, I am glad mine did.
I have always valued her insights and enjoyed passing them along to others who were curious about investing and how interest can work in favour of financial goals. That is why the concept of compound interest remains fascinating to me in all the years since. It is a simple concept that a young person can understand: if invested money earns interest, re-invested interest earns it too. Despite this simple yet powerful idea, fewer people than you expect act on it to make it work for them.
There is a quote that is often attributed to Albert Einstein - I do not know if he actually said it, but the point is well-made: “Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn't, pays it.
In my mind, compound interest is something that should be an essential part of the financial education of our children because, over time, it has some of the greatest impact on their future. The younger someone is, the more time they have to take advantage of compound interest benefits, and to have their money start to work for them.
Re-investing the interest earned on investments helps insulate people from short-term volatilities in the market because it is a long-term strategy that is based on keeping money invested, not cashed out. Long-term investments typically involve less risk and do away with worries about “timing the market.”
There are two means to making to the most of compound interest investing: patience and discipline. The first is patience. Patience because this is not a short-term day-trading investment play. To be strategic, it should be based on the sound advice of your financial advisor. Second is discipline. Discipline because it is tempting to start imagining spending investment gains before they have even been earned. Compound interest investment strategies must always consider the gains as additional investments, not as a windfall to cash out and spend. There must be a disciplined commitment to such approach. For example, direct deductions from your pay or income that goes directly into your investments before you have a chance to spend that money elsewhere.
The beauty of this strategy is simple - keep it up long enough, and it becomes a habit. Your nest egg grows and when it is time to check up on it, you will be pleasantly reminded of why you left it alone, and that is when you will enjoy the product of your patience and discipline.