MANY things in life can be both good and bad for us. Think about fire, sugar, and water, for a moment.
Fire warms us, yet also burns. Sugar sweetens our drinks and food, but too much of it brings about debilitating diabetes, and while water triggers and sustains life, we may drown in it.
Now consider compound interest as we figure out which side of the GCD, or Great Compounding Divide, we live on.
Those of us who are mired in debt are on — shall we say — the left side of the GCD.
In this figurative place or actual state, we pay interest to the people or entities lending us money. They give us credit, which morphs into liabilities, or debts, the moment we receive the loans, thus making them our creditors.
Most adults have creditors, and most creditor organisations are banks. Well, a little-known quotation attributed to Albert Einstein applies to this too-common situation:
"Compound interest on debt was the banker's greatest invention, to capture, and enslave, a productive society."
If you've ever toiled and worried, and toiled (and worried) some more, to pay off a loan — be it a car loan, mortgage, personal loan, unpaid credit card balance, or family loan — you'll understand Einstein's lesson encapsulated in his pithy observation, because you've been caught on the wrong side of the GCD.
The side that forks out payments on an array of loans with compound interest working FOR our creditors and thus AGAINST us.
Across that great chasm, lives a happier, smaller group: those who have no loans at all.
Instead, they possess positive yield generating assets, such as bank balances earning interest, stocks and Employees Provident Fund (EPF) balances paying dividends, unit trust funds generating distributions, and investment real estate providing rental inflows.
These people are better off because they have zero debts and only positive yielding assets that compound their wealth upward over time.
For this minority of adults, the Earth is their oyster and — mixing my metaphors — their playground.
GREATEST LIVING CAPITALIST
Warren Buffett is Earth's greatest investor. He is still alive and set to turn 94 on Aug 30 this year. His best friend, Charlie Munger, sadly is not, having died recently.
One of many biographies written on Buffett is entitled Snowball by Alice Schroeder. I bought my copy in October 2008, a month after it was first published. Here are three sentences from page 65 of my weighty, hardcover version:
"Warren began to think about time in a different way. Compounding married the present to the future. If a dollar today was going to be worth 10 some years from now, then in his mind, the two were the same."
Schroeder's insights into the formative thought processes of our greatest living capitalist are telling. I believe this is the crux of Buffett's saving and investing philosophy:
1. Get started. If there is a choice between starting early or starting late, start early. But if there is no choice, start now.
2. Bear in mind compounding takes time to build wealth.
3. The sheer power of compounding lies in anyone's ability to build a small snowball and to then roll it down a long, long hill.
Much has understandably been written about Buffett, so here is a link to a Money Thoughts column I wrote on the deceased Charlie Munger. He died late last year, a few weeks before what would have been his 100th birthday on New Year's Day 2024: www.nst.com.my/lifestyle/sunday-vibes/2023/12/988491/money-thoughts-char....
Munger once observed: "Understanding both the power of compound interest and the difficulty of getting it is the heart and soul of understanding a lot of things."
ALTER YOUR CONDITION
Let's now consider life on the left side of the GCD. Some there have no assets, only debts. They are in terrible economic shape. The larger subset, though, of that indebted population owns some assets and has some liabilities.
The more assets that are owned, and the fewer liabilities that are owed, the healthier the financial state of any person on the left side of the GCD.
Sadly, the compounding rates on most loans are usually higher than the long-term CAGR, or compounded annualised growth rates, that most assets like cash, stocks, EPF, unit trusts, and real estate investment trusts (REITs) can grow at over time.
This is important because the negative compounding rates of loans that transfer our wealth to our creditors are almost always higher than most of the positive compounding rates our productive assets earn for us.
That's why so many of us work and work for decades, yet have so little to show for it. To alter our condition, we should manage our cash flow better, retire our loans faster; and buy more high-quality investment assets over time.
Finally, just in case you're worried you don't have sufficient "runway" between today and official retirement, simply choose to delay retirement.
My advice to my financial planning clients is to not retire until every single debt is repaid.
Till then, I encourage them to keep working ever harder and ever smarter, ideally for rising pay.
© 2024 Rajen Devadason
Rajen Devadason, CFP, is a securities commission-licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on Twitter @Rajen Devadason and on YouTube (Rajen Devadason).