Wednesday, 11 April 2012 - 20:00
Compounding for the Long Run
Most investors have heard the saying, generally attributed to Albert Einstein, that compounding is the eighth wonder of the world. Compounding is a fairly straightforward concept (making gains on prior gains) but it can be very difficult to completely grasp as its effects are only truly felt over the extremely long term (think 20 years and more).
At the beginning of this year the Seed Weekly Report looked at 2 investors that invested a lump sum into the SA market (via the ALSI) for a 10 year period. Investor B used the dividends paid out to enhance his lifestyle, while Investor A slavishly reinvested the dividends. At the end of the period Investor A had 33% more invested than Investor B. While it is obvious that Investor A is better off, there can be the argument that the fruits that Investor B enjoyed as a result of his withdrawals could equal the financial value that he lost out on.
Agreed. Over a 10 year period, while compounding is good for your investments, the added benefits do not obviously always outweigh the opportunities lost. Over longer periods, however, the added benefits become more and more obvious.
For the purposes of this article, let’s assume that two 25 year olds each inherit R 100 000 from a distant aunt. They both decide that it’s not enough that they are able to stop working, but it’s a sizable amount that they want to invest in the stock market (ALSI – as they are able to take on the full market risk). Here their 2 strategies diverge slightly (or at least they don’t think there’s much difference at the outset).
The first recipient decides to reinvest his dividends with the following mindset, “This money is a windfall to me, and I don’t need to look at it or use it until I retire. I therefore want all my dividends reinvested”.
The second recipient is disciplined in that he wants to invest the inheritance, but would like to have a bit of extra cash each year to splurge, “I’m being responsible by investing the inheritance, but it won’t make much difference if I just have the dividends paid out to me as they are declared rather than having them reinvested”.
In the first 5 – 10 years the second recipient boasts that he’s a) got an investment that has grown nicely in real terms, and b) has ALSO been able to go on a few nice holidays and buy some new gadgets. The first recipient just keeps his head down, knowing full well that the power of compounding will kick in down the line.
At age 65 (retirement) the difference in size between the two portfolios is mindboggling! The portfolio that had the dividends reinvested is now over 5 times larger than the one that had the dividends continuously withdrawn. Both men have been made wealthy by their investments, but the one that reinvested his dividends has created significantly more wealth than his counterpart. The chart below shows the difference between the two portfolios using ALSI data over the past 40 years.
Less than 40% of the difference between the two portfolios can be attributed to the money that was spent on the holidays and gadgets. The remainder, over 60%, is the opportunity cost of not reinvesting the dividends. In this example, nearly R50m extra is generated through returns on the reinvested dividends!
While we agree that money can’t buy happiness, each investor needs to assess the pro’s of instant gratification versus the con’s of the opportunity cost of missing out on the compounding effect. Further, both investors did well by investing their inheritance rather than immediately spending it on a new car (or other depreciating ‘assets’), or a trip around the world, but one just did a WHOLE lot better than the other!
021 9144 966
Wed, 11 Apr 2012
Keaton reported substantial across-the-board production increases from its South African operations in the financial year ended 31 March 2012. The company's Vanggatfontein Colliery in Mpumalanga province delivered 955 376t of washed 4- and 2-Seam thermal coal to power utility Eskom between. . .
Shareholders of the company are advised that the European benchmark ferrochrome price has been settled at USD1.35 per pound for the second quarter of 2012, an increase of 17% from the USD1.15 per pound price in the first quarter of 2012.. . .
Investment income for the year ended 29 February 2012 soared to R63.7 million (2010: R22.8 million). Operating activities climbed to R342.1 million (2010: R283.3 million), while profit for the year increased to R334.6 million (2010: R259.1 million). Furthermore, headline earnings per share jumped to 30.7cps (2010: 18.9cps).
A final ordinary dividend of 4cps (2011: 4cps), in respect of the financial year ended 29 February 2012, was declared on 7 March 2012 and paid on 2 April. . .
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Latest Consensus Changes**
|NED||NEDBANK GROUP LTD||HOLD||05 Apr|
|SBK||STANDARD BANK GROUP LIMIT...||SELL||05 Apr|
|AIP||ADCOCK INGRAM HLGS LD||HOLD||05 Apr|
|IPF||INVESTEC PROPERTY FUND LT...||HOLD||05 Apr|
|LHC||LIFE HEALTHCARE GRP HLDG ...||BUY||05 Apr||
|Expected||Company Name||Fin. Date|
|16 Apr 2012||MAS||November 2011 (Q)|
|16 Apr 2012||PSG||February 2012 (Final)|
|16 Apr 2012||PSGFIN PREF||February 2012 (Final)|
|17 Apr 2012||DCENTRIX||February 2012 (Final)|
|18 Apr 2012||AFEAGLE||December 2011 (Final)|
|CIL||Consolidated Infrastructure Group Ltd.||16/04/2012||Confirmed||
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