Whenever hearing about compound interest, we would immediately think of usury. Usury is just using compound interest to keep debtors pay all the life for his loan. Nowadays house loan uses the same strategy.
Credit card companies also use this strategy. If only paying back the minimum amount every month, then soon card holder will be stuck in a trap to pay back all the credit bills.
In general, anything has two sides, good side and bad side. Compound interest is the same. For debts, it becomes a bad side to borrowers. But for investors, compound interest is a good friend and will bring profits. In theory, everyone can participate some type of investment. Therefore, compound interest can become a friend to anyone.
To calculate compound interest, we need to use some complex mathematical formulas, e.g. logarithm and N power. Is it so that compound interest calculation is sophisticated? Absolutely not! Warren Buffett said that investment only needs math we learned in elementary school. Einstein simplified the compound interest calculation and invented the famous Rule of 72. The great scientists are great because they not only can put forward the advanced theory, but they can also simplify the theory for daily need. In this aspect, the famous Chinese mathematician Hua Luo Geng was also great because he used mathematical knowledge to deduce the best recipe of fritters (a very common deep-fried Chinese breakfast).
Rule of 72 tells us an investment’s doubling time by dividing 72 with interest percentage.
|Interest %||Doubling time||Note|
|1.00%||72／1 ＝ 72||Similar to savings in QE|
|2.00%||72／2 ＝ 36|
|3.00%||72／3 ＝ 24|
|5.00%||72／5 ＝ 14.4|
|6.00%||72／6 ＝ 12|
|7.00%||72／7 ＝ 10.3|
|8.00%||72／8 ＝ 9||It is good enough for amateur investors|
|9.00%||72／9 ＝ 8|
|12.00%||72／12 ＝ 6||You can make a happy living with 12%|
|20.00%||72／20 ＝ 4||You will become second Buffett|
The expectation of investment should not be too much. During last decades, Buffett’s average annual rate of return is only around 20%. If you can achieve above 12%, then every 6 years your total investment will get doubled, you may be worshiped by other investors.
During last 35 years since China applied the open policy (1980-2014), GDP annual increase rate is 9,8%, and we have already seen dramatic changes. Don’t we get the powerful point of compound interest?
Investment is just so simple. Your target should not be too high. This year if you gain 100% and next year lost 50%, actually you are even. 8% is high enough target. The most important is long-term stability!
Compound interest is called by Einstein as the 8th miracle (wonder) in the world. Next article we will talk about how to utilize compound interest efficiently and effectively.