After discussing the importance of having money and knowledge in investments, the third critical component is time. Conventional impression about time is simply staying long term. The longer you invest the better. Ergo, unknown to the younger investor, he/she has an advantage over an older one. By putting time into investments means allowing the investment to grow in order for the compounding effect of money and dramatic growth to take effect. Many successful investors who realized this early on is at an advantage. It likewise embodies the idea of starting early in investments.
Here is an illustration to show how time impacts the investment result. Let us say there are two siblings, Anne and Belle. Anne is the eldest and she is 30 years old. Her younger sister is Belle who turned 22 years old and has started working. Anne in her early working years did not save up anything as she enjoyed her income. On the other hand, Belle who is more diligent in her finances and have learned a little about investments asked her sister Anne to start investing as well. So both of them invested at the same time. However, since Anne is earning more, she is able to set aside P20,000.00 a year. Meanwhile, Belle can only manage to earmark P10,000.00 per year to her investment. They both agreed that the investment is for their retirement and will do it altogether in the same investment instrument. Target age to retire is 65 years old. Guess who has more at age 65 if both of their investment performed an average compounded rate of 12%?
Anne who started at 30 years old investing P20,000 per year will have a total investment value of P8,633,270.00 by the time she becomes 65 years old. Her total contribution to her investment is P700,000.00 or 35 years multiplied by P20,000.00. It is not a bad return. On the other hand, Belle is able to muster a total investment of P430,000.00 or 43 years multiplied by P10,000.00. However, her retirement fund when she reaches age 65 is P10,810,826.00! Belle has more money than Anne but for less amount. The critical component of the equation that makes up the difference between Anne and Belle’s retirement fund is the time horizon of their investment. Anne has only 35 years to build her fund while Belle had 43 years. Even if Anne put up more amount than Belle, she is still short of what Belle has upon reaching the same age. Imagine how much more Belle would have if she added up on her investment during the period.
This is the compounding effect of money. The longer you invest the greater you will make – as long as you keep the earnings or gains intact with the principal. Because in what happens is the gains of the investment becomes part of the principal that will hasten the growth. There is no compounding if you will take out the earnings every so often. Some call this is the magic of compounding. It is indeed a magic for many because they do not realize it until the latter part of their life.
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