Albert Einstein said it best, “Compounding interest is the 8th wonder of the world. Those who understand it, earn it. Those who don’t, pay it.” This quote speaks greatly when you start understanding the importance of long term investing.
Let’s start by defining the term interest; in finance and economics interest is the amount charged, expressed in a percentage in terms of the principal amount a borrower charges to a lender or the investor expects to receive as a return for an investment. Therefore it becomes imperative in knowing how interest functions when you seek to invest.
In investments strategies, interest goes one step further and speaks to compounding interest, and this is basically earning interest on interesting, hence the term compounding. As an investor you want to be able to take advantage of such a phenomenon, and these are some of the factors one should be cognisant of.
For any investment to make positive gains, the investment needs to be subject to long term investment strategies. The reason being when you enter financial markets no matter what asset class you may be invested in, the market has cycles of upswings, downswings, flat return (as experienced in South Africa in the past 5 years), and consistent growth trajectories. Therefore by having a longer time horizon, you provide your investment portfolio with the necessary time to recover should there be downswings or flat returns and when there are upswings and growth in the market it is able to take advantage of these cycles.
Asset allocation refers to being invested in different asset classes such as; bonds, equity, property or cash. It is vitally important that when constructing your investment portfolio (depending on your risk tolerance) you allocate your investment capital to asset classes that will provide greater returns, in order to earn more interest or returns on these investments. Should the investment portfolio be constructed appropriately, you will be able to compound your returns on an annual basis.
Investing, and avoiding debt
Ensuring that the bulk of your disposable income goes towards your savings and investment. At SimWealth we love to use the 50/30/20 rule; which is 50% of your income should go towards your necessities, 30% towards your savings, and 20% towards lifestyle and leisure. Warren Buffett said it quite profoundly in that when you receive an income, firstly save and then spend what is left.
By applying these methods of investing you will ensure that you and your investment portfolio get well acquainted with the 8th wonder of the world – interest.