%20(transparent%20bac.png)
“Time is the friend of the wonderful business, the enemy of the mediocre”
-Warren E. Buffett-
A few days ago, I came across a very interesting survey in The Australian Financial Review. The participants were asked five questions, including:
Suppose you put $100 into a no-fee savings account with a guaranteed interest rate of 2% per year. You don’t make any further payments into this account, and you don’t withdraw any money. How much would be in the account at the end of the first year once the interest payment is made?
Imagine now that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, would you be able to buy more than today, exactly the same as today, or less than today with the money in this account?
True or false: Buying shares in a single company usually provides a safer return than buying shares in several different companies.
True or false: An investment with a high return is likely to be high risk.
Suppose that by the year 2024 your income has doubled, but the prices of all the things you buy have also doubled. In 2024, will you be able to buy more than today, exactly the same as today, or less than today with your income?
If you’re keen, have a crack at them. I encourage you to attempt to answer these questions first (answers are provided at the end of the post). Then feel free to scroll down to the bottom and check your work.
Before sharing my thoughts, here is what the survey found.
Most Aussies can’t answer these simple money questions. Researchers, based on the results, concluded that Australians’ financial literacy went backward between 2016 and 2020.
Those aged between 15 and 24 scored 2.9 out of 5, compared to 3.4 in 2016. Respondents aged 25 to 34 got 3.6, against 3.9 in 2016 (There is more to it, and I will include a link to the article in case you are interested to read on).
If you got all five, congratulations! You’re doing better than most of your fellow Australians. You should be proud of yourself.
But if you don’t, there is nothing to worry about. Realising what you don’t know or should know is often a great start. The idea is to become more aware of the importance of financial literacy. You will soon have to make some decisions that have a lifetime impact, so it is better late than never to start getting your head around these simple concepts which may play a huge role in how your future pans out.
And here is what I found interesting about this survey.
From my perspective, if you can take away anything from that questionnaire, it’s that most of the fundamentals of wealth generation are neatly wrapped up in questions one, two and five.
Sound simple enough? Let me elaborate.
Let’s start with questions two and five.
Inflation – the overall increase of consumer good prices - basically is what destroys the value of your hard-earned money. To be more precise, the purchasing power of your hard-earned money.
What that means is the dollar you have in the future would be worth less compared to what it is today because the cost of living is rising (and you should know that the authority wants to keep inflation at a “healthy” rate of 2% indefinitely). It is sad but critical to know that your salary doesn’t always increase at the same rate as inflation.
Remember when you could buy a movie ticket for just $5? Now, it is $25, thanks to inflation.
In 2020, the average house price in Hobart is $495,000, according to ABS. If you could travel back in time to early 2000 with the same amount of money, you could easily buy 2 houses in inflation-adjusted dollars.
Therefore, investing is important. It significantly lightens the burden of saving for your retirement while keeping the value of your money ahead of inflation. Many people don’t think about this until much later in life (often when it is too late).
“But how can investing do this?” you might ask.
And this ties up perfectly with what question one in the survey seems to imply. Let’s go over it once again.
In short, if you put $100 in a bank’s saving account that guarantees an interest rate of 2% a year, you’d have $102 in total at the end of the year, including your initial $100 plus $2 of interest. Sounds great, doesn’t it?
How about if you keep that $102 in the same saving account and leave it for another year? By the end of the second year, you’d now have $104.04, including the $102 at the beginning of year 2 plus $2.02 interest. That is $4.04 of free money!
The best part about this is that you don’t have to do anything. In another word, your money is working for you 24/7.
This is what compounding is – the process by which the returns (in this example, guaranteed rates) of an asset (saving account) are reinvested. You earn interest on interest on interest …
I am having fun! Let’s do this for another year. Let’s keep the compounding wheel rolling.
Leave that $104.04 untouched and check the balance at the end of year 3. You’d now have $106.12, with $104.04 at the beginning of year 3 plus $2.08 interest.
And guess what you’d end up having after 30 years? The answer is $181.14. Thirty years of doing nothing earns you $81.14. Not too bad, hey.
It might seem insignificant at first in the absolute figure. After all, we all know for sure that you don’t want to retire with just $181.14. We need much more than that. It would not be even enough for a weekly coffee budget.
But don’t forget that it is just a saving account, which historically earns you a relatively same rate. Buckle up and let’s bring investing into the game and see how we can spice it up a little bit.
Suppose you manage to find an investment option that promises you a 7% return per year. Starting with $100, by the end of year 30, you’d have roughly $761. That is seven times your money. Keep in mind that at this point, you are still doing absolutely nothing. Your money is the real MVP here!
If you start with $1,000, you’d end up having $7,610 in your account when you retire (when your back tells you that it is not okay to stand up all day and your doctor suggests that you should just rest and enjoy life).
By now, you realise how magical this compounding thing is and want to take things to the next level. You decide to put aside $200 each month and contribute to this investment.
After 30 years, with a humble amount of $1,000 at the beginning and a simple act of investing $200 month after month, you’d be happy to see that the balance in your account would be $234,418. Yes! It is a six-figure number, and yet you still don’t need to do much.
Again, your money is doing all the hard work. It works seven days a week, 365 days a year. It is immune to all kinds of viruses and doesn’t take sick leaves. It works while you’re asleep, night and day.
Ultimately, the point is the earlier you start investing, the better your life will be (financially). The longer you allow your investment horizon to be, the more powerful the compound effect will work in your favour.
This brings us back to what Buffett says up the top.
You are the wonderful business of yourself and on this journey, time is your ally.
“So how do I find this investment that gives me a 7% return?” – I will save this for the next one. See you there.
Thanks for reading!
Answers: 1. $102 2. Less 3. False 4. True (Though I beg to differ. There’ll be a post about this topic soon) 5. Exactly the same
***
Contact:
admin@oceansidefamilyinvestment.com
Comments