The Magical World of Compounding Interest

I’m sure I’m not the only one that have enjoyed the thought of having an obscene amount of money. Not for the purpose of endless consuming however, but for the purpose of freedom (but if you love money because you love consuming that is perfectly fine – I do too – to a certain degree). For…

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I’m sure I’m not the only one that have enjoyed the thought of having an obscene amount of money. Not for the purpose of endless consuming however, but for the purpose of freedom (but if you love money because you love consuming that is perfectly fine – I do too – to a certain degree).

For a very long time my biggest anxiety was that I wouldn’t have enough money to do what I wanted as an adult. Before I started my college education I worked at a local grocery store – I worked long hours and at the end of the month my paycheck was above average for an uneducated person of my age. Still I wasn’t satisfied – I wanted more time (and money) – because at the end of the day the only thing we have in life is time. We sell our time to other people or companies that pay us money in return. I didn’t want to be restricted to the amount that was written on my paycheck at the end of the month, I didn’t want to plan my entire life around a number. Unfortunately, a lot of people do this, myself included at the time.

Statistics show that – as a person’s salary increases – the amount of money left in their bank account at the end of the month is still the same as it was before their raise. Which makes perfect sense at first glance because when you have more money you spend more money – whether it be on ice cream or fancy scarves.

I was made very aware of how dependent I was on my paycheck when I suffered a back injury while at the gym one day. My doctor diagnosed me with a herniated disc and told me that I wouldn’t be able to work for a couple of months. When I got my first sickness benefit I was shocked – it didn’t come close to my “real” monthly paycheck, luckily I had some money in my savings account. At the beginning of this period I was very downhearted – I couldn’t work or go to the gym (which I love). I just sat in my apartment feeling sorry for myself and thinking about how unfair the world is. I quickly realized that this was completely unreasonable – I had to do something productive with my time – not sit around and let my life fade away.

I have always enjoyed reading so I thought that I might as well spend my time doing that instead of picking my nose all day, and perhaps I could learn a thing or two along the road. I have always preferred non-fiction so that was the obvious genre of choice. One of the books I picked up was about the stock market, personal finance and investing. After finishing the book my mind was blown – I had always thought the stock market and investing money was full of risk and only for the few initiated; I was wrong. The author introduced me to the 8th wonder of the world – compound interest. To put it in the famous words of Albert Einstein:

“Compound interest is the eight wonder of the world. He who understands it, earns it … He who doesn’t … pays it”

As I said earlier I had some savings that helped me through my sick leave period – this money was placed on a normal savings account with a very low interest rate – I think I earned something like 0.1% every year. In real money this translates to a yield of 1004,5 kr (≈1%) in 10 years, assuming your initial deposit was 100,000 kr. I don’t know about you but it doesn’t tickle my fancy to put aside 100,000kr today to earn 1004,5 kr in 10 years. I’m sure some banks offer better interest rates if you agree to a 10-year period, but it still doesn’t come close to what the stock market offers. From December 31st ’92 to December 31st ’15 the average yield on the SIX Return Index (SIXRX; is an index that consists of all the publicly listed companies on the Stockholm stock exchange) was 13.48%. In real money this translates to a yield of 254,155 kr (≈254%) in 10 years, also assuming your initial investment was 100,000kr and that you reinvested the yearly dividends. Both of these examples also assume that we don’t put aside any money monthly whatsoever. The longer we save, or invest I should say, the obscener the number gets. Now this why compound interest is so mouth watering to me.9677861633_cc1d703f56_b

But how does one take advantage of this without know much about the stock market or stocks in gen- eral? It’s actually really easy, with a few notes that can’t be mentioned enough:

 

  1. Be certain that you’re not going to need the money you invest for a long time (my own investment horizon is at least 10 years). The longer the horizon the more powerful the compounding interest becomes.
  2. Invest regularly – It doesn’t have to be massive amount of money but make it a habit. Something that worked good for me was to create an automatic transaction that took place the same day I received my salary, from my bank account to my stock broking account.
  3. Diversify your investments – don’t put all your eggs in the same basket. As with any investment there is risk involved in buying stocks. The more you diversify the less you are exposed to that risk. If you want further diversification I would recommend buying investment companies, because when you do you also buy the companies that the investment company owns. There are also funds called index funds which follow the movement of a certain index (SIXRX for example). I stick to the ones without a management fee because as we saw earlier a few percent can add up to a lot during a long period of time. Personally I only own stocks and as of right now twelve of them.
  4. Buy companies you believe in and/or understand – This makes investing so much more fun, you can be part owner of your favorite brand, whichever industry they operate in.
  5. Don’t be disheartened during bad times. A lot of millionaires were made during the 2007/8 housing bubble and stock market crash because of all the cheap stocks available for sale.
  6. Last but not least in the words of Shia LaBeouf: “Do it!”. The sooner you start the more money you will make. So just do it – don’t let your dreams be dreams.

There are a lot of online stock brokers these days, I recommend you pick the one which has the most attractive user interface to you. I use Avanza but there are many others. I also recommend the account called ISK (Investeringssparkonto – Investment savings account). It lets you pay a standard tax (a very low percent) on the total amount you have saved instead of paying a tax on the profits your investments make.

All in all, I swapped my anxiety of not having enough money to anxiety of not knowing what I want to do with my life; you should too. In other words: I got 99 problems but a diversified stock portfolio ain’t one. Best of luck and happy investing!

 

About Nådiga Lundtan

Founded in 1948 and has since been an important part of student life in the economics program at Lund University. Nådiga Lundtan covers a wide range of topics related to economics, society, and politics, as well as careers, entrepreneurship, and innovation. It is a platform for students to share their ideas and opinions on economics and related fields.

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