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Weekend reading: Interest is interesting

Money articles

My regular roundup of the week’s blog and financial site links.

I think you can divide the world up into people who have a spiritual epiphany when they learn about compound interest, and those who just shrug and buy more tat on their credit card.

When I first learned about compound interest, my life changed forever. I won’t say it changed for the better – saving half your income and writing a blog about it isn’t a surefire way to win over the ladies – but after 20 minutes playing around with a compound interest calculator I was an investor for life.

Weirdly, I’ve still not written about compound interest on Monevator, despite it being one of my favorite dinner party conversations.

Instead, this week I wrote about making money on the iPad, rebalancing and taxes, and new ETFs for Australia, Canada and South Africa, which means another week went by without my penning a love letter to the miracle of escalating returns.

But Investor Junkie, a US blogger, did cover the power of compound interest in his post How much is 1% costing you?, so it’s my blog post of the week.

He writes:

“I find compound interest pretty amazing.  It’s believed Einstein once said compound interest “is the most powerful force in the universe”.

Too right. Einstein, me and Investor Junkie, all united by the enigmatic charms of compound interest.

The point of his article is to show how a difference of just 1% can damage your long-term returns (let alone the 3% or more a blood-sucking financial adviser could be leaching out of your retirement fund).

Just check out the following table to see what a difference 1% makes:

Years 8% Return 7% Return Difference % Difference
5 $58,666.01 $57,507.39 $1,158.62 2.0%
10 $144,865.62 $138,164.48 $6,701.14 4.6%
15 $271,521.14 $251,290.22 $20,230.92 7.5%
20 $457,619.64 $409,954.92 $47,664.72 10.4%
25 $731,059.40 $631,490.38 $99,569.02 13.6%
30 $1,132,832.11 $944,607.86 $188,224.25 16.6%

New UK credit report site

Finally, Jessica from Credit Report wrote to me to flag up her new UK site that offers all kind of advice about maintaining a decent credit file. 99% of such emails are spam, but this site looks like the real thing and has plenty of good advice.

More highlights from the personal finance blogs

Other interesting financial and money articles

  • Commercial bankers whine to Peston about bonuses – BBC
  • …while central bankers whine to his chum about bankers – BBC
  • Time to buy listed private equity funds? – FT
  • Investors warned about lifestyle funds – FT
  • Multi-asset investing strategies – The Independent
  • Pimco is exaggerating threat to gilts – The Telegraph
  • Nationwide: UK house prices to rise 10% – The Telegraph
  • The iBook of Steve Jobs – The Economist
  • Mining the FTSE for bargains – The Motley Fool

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{ 19 comments… add one }
  • 1 Adam January 30, 2010, 3:29 pm

    Hi Mr Monevator!

    I feel the same way about compound interest and this idea, coupled with reading a few blogs, including this one, has inspired me to start my own: its currently live but launching properly shortly.

    Oh, and I’ll be trying to prove you wrong about wining over the ladies given that I am rich in an age sense after all.
    .-= Adam on: Hello world! =-.

  • 2 RetirementInvestingToday January 30, 2010, 3:43 pm

    Compound interest also changed my life forever. We sound like very similar people. I’m also a little extreme when it comes to saving for my retirement at around 60% of my gross salary. I’m also trying to encourage others by writing a blog about my experiences as I try and make work optional (retirement).
    .-= RetirementInvestingToday on: UK Property Market – January 2010 Update =-.

  • 3 Investor Junkie January 30, 2010, 4:10 pm

    Thanks for the shout out! Hopefully everyone starting investing early in life.
    .-= Investor Junkie on: How I Learned Everything About Business By Owning A Lemonade Stand =-.

  • 4 Faustus January 30, 2010, 4:34 pm

    I agree that compound interest looks like magic in the long run, but isn’t it difficult to make such calculations based on investments in equities? The volatility means you might get a 25% rise all at once and then lose 15% for the next two years, which rather scuppers the principle of compounding. Different story if you invest in high dividend stocks, perhaps another point in their favour.

    RIT –

    Wow – saving 60% of gross salary is definitely extraordinary. I’m guessing you must be either super wealthy (given that for most of us 60% is about all we have left after taxes) or live extremely frugally (maybe rent free)!

    Agree with your latest post about the future of House Prices in the UK – if we apply Get Rich Slowly’s principles in the link above, most places in Southern England are still extremely expensive on the price-rent ratio, and are at unsustainable levels in the medium term given falling/stagnant earnings and interest rate rises. There are much better places to put capital for the time being.

  • 5 ermine January 30, 2010, 5:02 pm

    You might want to also pay homage to compound interest’s evil twin brother, inflation. The mechanics are the same, but kill you over the long term instead 🙁

  • 6 swebb January 30, 2010, 7:58 pm

    Thanks Mr Monevator but where is a link to an online calculator. it took me ages to find this one on bloomberg http://www.bloomberg.com/invest/calculators/returns.html.
    even has inflation…

  • 7 The Investor January 30, 2010, 8:15 pm

    @swebb – Good point! I’ll also link to the MoneyChimp one I tend to daydream with into the article.

  • 8 The Investor January 30, 2010, 8:31 pm

    @Faustus – Good point. Volatility is super interesting. To link to MoneyChimp again, its articles on volatility are brilliant if hard going. Try playing around with its Monte Carlo calculator to see how volatility affects returns.

    @ermine – True, unless you’re in debt (or in a house with a mortgage!) Sadly, I’m not.

    @Investor Junkie – Agreed, they should teach compound interest to those who’d like to learn in special classes in school, when you’ve enough decades left to smooth the returns.

    @RIT – Yes, we do sound similar. I have to say I’m having second thoughts about some aspects about the way I’ve gone about life so far, though, re: the balance between earnings, saving and spending. I’m going to post on this on Monday, if I’m not too tied up doing the earning.

    @Adam – Good luck with the new blog!

  • 9 Davy Jones January 30, 2010, 9:55 pm

    Wow .. it’s good to know your not alone ! , remember my bro sitting down with me when i was 13 explaining via calculater what happens to £10,000 at 10 % compounded growth , i was simply astonished & yes for minds that are open , your never the same afterward

    One of the slight problems with human thinking is we tend to think in linear terms so we can understand simple growth rates , yet exponential growth rates seem unbelievable .. though they are just as real

    If computing power continues doubling as it currently is , it will be a billion times more powerful in 25 years , this goes way beyond compounding rates .. though you have to wander with exponentials if they will eventually hit brick walls until another paradigm moves it forward again

    @RIT , nearly up with you there investing 50% , paid my 3 bed council house off years ago so rent free now

  • 10 Financial Samurai January 31, 2010, 5:34 pm

    Hi Mate, thought I asked you a question here, but guess i forgot.

    Do you know if the 50% tax on bonuses your gov’t implemented is on top of normal taxes i.e. $50,000 is taxed at 30% normally, so the remaining $35,000 is taxed AGAIN at 50%, or is the 50% tax just a 50% tax now on $50,000….. so the marginal increase is 15% in this example?

    thnx
    .-= Financial Samurai on: The Katana: Rough Waters On The Horizon =-.

  • 11 The Investor January 31, 2010, 6:24 pm

    @Sam – The 50% tax is levied on the bank’s bonus pool, as I understand it. So say the bank has a bonus pool of £100 million – it would have to pay £50 million tax on that, *then* pay the remaining £50 million to employees. As you imply, the employees then pay tax as usual on their bonus. (40% in the UK at the highest rate).

    For the time this one-time tax applies, it is therefore incredibly expensive for a bank to pay a big bonus, which was the whole point – it was meant to encourage them not to pay bonuses, and instead to repair their capital ratios. But bankers are to money what kids with a big straw are to a milkshake: Slurp! Slurp! So they’re paying them anyway, and it’s shareholders and perhaps customers that will suffer.

    Incidentally, I read in The Sunday Times that even the former Chief Economist of the IMF agrees with me about bankers, saying: “They think they are worth the money. They are not.” (He is blogging at http://baselinescenario.com/).

    As ever, I’m not saying bankers don’t work hard, doing a difficult job that deserves a relatively high salary. I’m saying they’re not entitled to the billions they appropriate on top.

  • 12 The Investor January 31, 2010, 6:32 pm

    @Davy Jones – Indeed. There’s a spooky mind game proposed by the Astronomer Royal Sir Martin Rees (I think) about the potential of ever-increasing computing power.

    Long story short – if we assume computer power keeps doubling as rapidly as it has, we can assume we will eventually be able to simulate worlds, physics, universes, and universes containing computers simulating universes. At this point it becomes statistically unlikely you’re *not* living in a simulation!

    Welcome to The Matrix.

  • 13 Money Reasons January 31, 2010, 6:41 pm

    I thought Investor Junkie’s post was a good one, but I don’ t know if I believe the Einstein quote. For an analysis around the Einstein quote, check out the snopes.com’s take on Einstein and Compound interest.

    If anything it was probably a tonque-in-cheek kind of quote… Perhaps something like:
    Interviewer: Albert, what is the most powerful force in the universe?
    Einstein: compound interest (then laughs probably followed)…

    So, I’m sure it was taking out of context, but still Einstein surely respected the invention and principals of compound interest..

    Sorry if I’m getting a bit nit picky here… but I just want to get the facts straight. I hate it when things are taken out of context and used as absolute fact… After all, do we really think that Einstein really though that “compound interest” was really the strongest force in the universe?

    I’ll get off of my soapbox nowm Sorry if I expanded too much on this piece… I really did like Investor Junkie’s post… but that particular quote did make me cringe a bit.
    .-= Money Reasons on: MoneyReasons Weekly Cache – 2010, Jan 31 =-.

  • 14 The Investor January 31, 2010, 8:40 pm

    @Money Reasons – Yeah, I know where you’re coming from. It’s like that image of Einstein sticking his tongue out. He probably did it once in his adult life, and everyone remembers “crazy, playful Einstein”. I these slightly silly things bring these geniuses back into a human scale, sometimes.

    That said, I still like the quote! 😉

  • 15 Lemondy February 1, 2010, 11:18 am

    The Telegraph article on gilts is just a copy and paste of Richard Woolnough’s post to the Bond Vigilantes blog: http://www.bondvigilantes.co.uk/blog/2010/01/28/1264688880000.html

  • 16 The Investor February 1, 2010, 1:21 pm

    @Lemondy – I think copy and paste is a bit harsh… surely The Telegraph piece is an ‘accessible reinterpretation’. 😉

    A good reminder to check out Bond Vigilantes more in 2010 though… I think this will be an interesting year for bonds (and for what it’s worth (not much!) I agree more with Pimco that UK gilts are over-valued, even after the declines we’ve already seen since I began opining this in late 2008).

  • 17 The Digerati Life February 4, 2010, 2:24 am

    Thanks for the mention! I also saw the light when I first learned of the power of compounding. Thanks for bringing it to light here.
    .-= The Digerati Life on: Citi Mobile for the iPhone Free Download =-.

  • 18 Investor Junkie February 4, 2010, 5:40 am

    @Money Reasons: Yea I knew about this… Hence why I said in my post “It’s believed Einstein once said..”

    snopes.com states “Status: Undetermined”
    .-= Investor Junkie on: How Much is 1% Costing You? =-.

  • 19 Investor Junkie February 4, 2010, 5:42 am

    Either way it’s a good tie in that you have to be a “genius” to invest… ha get it? I don’t know if people caught my pun. 😉
    .-= Investor Junkie on: How Much is 1% Costing You? =-.

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