Power of Compounding

What is compound interest and why is it so important?

What is compound interest?

Compound just means something that comes in two parts. Interest is the addition of a small amount of money at the end of the year to the money that you had at the start of the year.

Compound interest refers to the additions of a small amount of interest on the interest that you earned in earlier years. In other words, the addition of a small amount of money to the small amount of money you earned the year before.

Why is it so important?

The table below shows what happens to $100 over 1, 5, 10 and 30 years at different interest rates. If we started with $100 and held it for 30 years at 2.0% interest, you would expect $60 of interest, so you’d end up with $160 at the end of the 30 years. But my table shows $181. Where does the extra $21 comes from? The extra $21 comes from the 2% interest that you’d earn on the interest that was earned in the year before, ie. The compound interest. Taken over time, the 2% extra you earn on the 2% interest, taken over 30 years adds up to $21, or 21% of your starting sum!

This effect becomes far more powerful once the interest rate or growth rate becomes higher. At 5.0%, $100 becomes $432 after 30 years. Once we start considering stock investing type returns at the 10 % to 12% levels, compounding leads to $259 and $311 after 10 years, and the large sum of $1745 and $2996 after 30 years.

Conclusion: compounding is a powerful effect.

Effect based on $100

Growth Rate 2.0% 5.0% 10.0% 12.0%
Years        
1 102 105 110 112
5 110 128 161 176
10 122 163 259 311
30 181 432 1,745 2,996

Melvin Tan

Melvin joined DCG Capital in 2011 and is a portfolio manager with more than 13 years of experience in investment management.

Previous experience: Lion Global Investors, Technology and Telecommunications; Straits Lion Asset Management, information technology portfolio implementation; Avanade Asia, software engineer.

Academic and post-graduate qualifications: Bachelor of Engineering (Honours), National University of Singapore; CFA® charterholder.

Teck Jin Tan (“TJ”)

TJ joined DCG Capital in 2014 as an investment analyst with more than 8 years of experience in investment management.

Previous experience: Target Asset Management, Greater China equity; Deutsche Bank, Hong Kong, macroeconomics and equity strategy; Singapore Police Force, securities fraud.

Academic and post-graduate qualifications: Bachelor of Engineering (Honours), Master of Engineering, Cambridge University; MBA, Columbia University; CFA® charterholder.

William Toh

William joined DCG Capital in January 2019. He has more than 25 years of investment experience.

From 2007 to 2018, he was the Chief Investment Officer of New Harbour Capital Partners and Lead Portfolio Manager of the New Harbour Asia Fund. Prior to that William was the Chief Investment Officer of Asia General Holdings responsible for managing the insurance funds of Asia Life Assurance and Asia Insurance (2001-2006). He started his investment career at GIC in 1981.

William is an Independent Non-Executive Director of Mapletree Industrial Trust Management Ltd and also serves on the investment committees of several Mapletree property funds. He is Chairman of the investment committee of the Methodist Church of Singapore (since 2013) and a member of the investment committee of Singapore Bible College (since 2008).

William studied at the University of Tasmania, Australia on a Colombo Plan Scholarship and graduated with a First Class Honours degree in Mathematical Economics. He also attended the CFA Investment Management Workshop presented jointly by CFA Institute and Harvard Business School.