Back to Basic – Compound Your Way to Retirement May 24, 2018

The current retirement age in Singapore is 62, while re-employment age was raised from 65 to 67 in 2017. Does the increase in retirement age coincide with growing longevity, or does one simply not have enough to retire. Personally, I always hope that I can retire earlier but of course there will always be a passionate group that prefer continue working despite their age.

We want to bring our investors back to the basic, understanding one of the more critical concept known as “Compounding”. “Albert Einstein once said that the power of compounding is the eighth wonder of the world”, so what exactly is compounding? If you refer to Investopedia, compounding is the process where the value of an investment increases because the earnings on an investment earn interest as time passes.

So why is compounding important? Let us take a look at the net worth of 3 fictional individuals who save $6,000 at the beginning of every year ($500 per month), for 30 years:

Mr Milo Tin:        I love putting my cold hard cash into the Milo Tin just like my Grandma.
Mr Savvy:            I love investing in dividend yielding asset but did not invest those dividends received.
Mr Compound: like Mr Savvy, I invest in dividend yielding asset but I reinvest those dividends.

Assuming both Mr Savvy and Mr Compound invest in a 5% dividend yielding asset. Throwing the numbers into an excel spreadsheet, their total worth including all dividends collected after 30 years differs by close to a whopping $100,000. Mr Milo Tin, of course, is nowhere near both of them. This example is straightforward, but is on the assumption that the asset price does not lose value over the years.

Since we know the importance of compounding, I will touch on 3 fundamentals which are simple, yet easily missed out by others.

1. Discipline, Due Diligence and Diversification

Firstly, owning a dividend yield asset does not equate to compounding (unless those with scrip options!). Do remember that you need to manually re-invest these amount to achieve the compounding effect.

Secondly, owning an asset is equivalent to owning a business, so choose those that you know and trust. There will be times whereby market conditions have changed, and the investment thesis do not hold. Under such circumstances, investor must be prepared to cut losses.

Lastly, not all risks are predictable, so it will be wiser not to put all your eggs into a single basket. Allocation into non-correlated sectors will help to lower the overall risk of the portfolio.

2. Dividend Yield is not everything

Some investors have the perception that compounding can only be achieved through assets that distribute dividend. As for me, I beg to differ. In reality, there are companies that do not give out dividends but continue to reinvest in themselves, driving higher profitability year after year. The fruits of such performance are usually an increase in share price. Considering potential total return, investors should not place full emphasis on dividends and lose sight of those.

3. Starting Early is Key

Yes, the amount you invest every month or every year is important, but the real deciding factor is how much time you have to compound those returns. If we were to take a look at the earlier chart, the spread between Mr Savvy and Mr Compound widen as the years pass on. With this, the earlier you start compounding, the more years you would have to compound your returns, and the numbers will only get bigger.

Conclusion

Having a game plan is the first and most important step for any investment. We hope that through such sharing, we will help you towards your financial goals.

If you wish to know more about investing, feel free to approach your designated Trading Representatives or our friendly Representatives at a Phillip Investor Centre near you.