However, Albert Einstein was also interested in more mundane subjects such as personal finance and the effect of compounding. Compounding can certainly be a blessing for your savings and a nightmare for your debts. Compound interest is the interest you earn on your interest as long as you don’t withdraw your interest payouts from your principal. The result is exponential growth instead of linear.

You will be able to observe the full benefit of this “wonder of the world” at the end of the investment term and that is why is very important to start leveraging it as early as possible in your life. You will clearly visualize it by playing with this simple calculator and the parameter “years to grow”. Here there is also a good example of the importance of starting early.

How to save and invest with compound interest

Saving and investing are two different things. The first is putting aside money for a rainy day whereas the second is using your money to acquire assets with the hope that their value will grow over time. The difference is mainly the risk you are willing to take.

Depositing your money in a savings account or a fixed deposit involves low risk, you may lose your savings only in the event of your bank going out of business. Having said that, Singapore insures deposits up to S$75k. Technically one can only lose money if his savings exceeds that amount. On the contrary, money “invested” has the potential to 100% vanish if the underlying asset value goes to zero.

Anyone can earn compound interest on his nest egg just by depositing money regularly in a savings account. The problem is that the current interest rates in most first-world countries are sub 1% so you will need a considerable amount of time -if nothing changes- to see significant growth. Arguably this low interest can’t even protect your savings from inflation which itself also compounds.

Then what?

You clearly want to get the most yield from your hard-earn money and enjoy the benefits of compounding. The following are some examples of investments you can leverage:

Stock market and bonds

When you buy a stock you are mainly buying a little portion of a company. Whereas when you buy a bond what you are buying is the company’s debt (or a country’s debt). Bonds are boring assets that yield very little but are able to cushion your portfolio’s unrealized losses during a market dip. It can be wise to buy bonds once we approach retirement in order to avoid the portfolio’s value swings. Most of these assets pay dividends, by reinvesting them the compounding magic happens.

Stock picking can be an art more than a science. It doesn’t only requires hard-skills but a high dose of psychology in order to stick to your plan when the markets are choppy. Due to this and to sleep better at night, many people prefer to buy exchange-trading funds (ETFs) or mutual funds. Funds allow investors to “buy the market” and better diversify their portfolio. These products are managed by companies at a cost. Hence, it is important to select funds with efficient management fees in order to protect your yield and ultimately, your compound interest.

Gold and silver

Buying precious metals is as old as the hills. Metals have a purpose, humans build things with them, especially gadgets. Our laptops and smartphones contain gold, silver, copper, platinum, and palladium.

Metals are also finite resources. Someday there won’t be any gold left to mine. These characteristics give metals such as gold intrinsic value and a very interesting investment to protect us against the “inflation rat”.

Cryptocurrency

Cryptocurrencies are trendy. We are in the midst of a Bitcoin craze. Bitcoin was the first digital currency based on blockchain ever created. This underlying technology is what makes Bitcoin so special. The blockchain eliminates the need for centralized authority and a distributed network of computers makes sure every transaction is secure.

As previously explained, scarcity and utility determine the economic value of goods. While Bitcoin is capped to a maximum of 21 million which makes it scarce, the utility of the currency seems more questionable. The project initiated by Satoshi Nakamoto aimed to facilitate transferring cash between parties. However, due to their current volatility, this idea seems far from reality. On a positive note, some expert voices in the space claim that Bitcoin will eventually find equilibrium and become more stable. We’ll see.

The reality is that the value of Bitcoin has soared manyfold against the USD since its inception and, in my personal view, should complement a well-diversified asset portfolio.

Real estate

Investing in bricks and mortar requires far less knowledge and seems a safer bet than the previous. After all, we can live in it. That is for many sufficient arguments to decapitalize themselves and purchase a house. Personally, I think there is a huge opportunity cost involved unless you are able to find a real bargain.

The average John Doe will need to ask for a mortgage and make sure he has the means to religiously fulfill his mortgage payment every month. He might forget refinancing and end up paying more than he should in interest. To his relief the interest he will pay is simple, interest in mortgages does not compound.

Perhaps owning your home is not a bad idea, after all, psychology in financial planning is as important as the potential profits. Many people will purchase a house as soon as they can in order to achieve mental peace. Even if it’s financially inefficient.

Buying property as an investment with the intention of renting it is more controversial:

• In Singapore a 12% stamp duty is imposed for second property buyers.

• This kind of investment belongs to the realm of the “analog world” and the productivity tools you have at your disposal evolve at a much slower pace. You will most likely need to meet your tenants, reply to their queries on Whatsapp and even buy and install a new washer if the existing one breaks. Should you want to outsource all this, you can, at a cost.

• In some countries, if your tenants stop paying the rent you may not be able to even kick them out of your own place. This of course is not the case in Singapore where the landlord always has the upper hand. Majulah!

Conclusions

Compound interest is powerful. Its magic is more visible the longer we live and invest. On the other hand, that magic can turn black if we don’t pay our credit card bills on time or borrow money without a solid plan to pay back.

Thank you for reading my first post and to more exciting topics!