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The Power of Compounding

The Power of Compounding. Compounding creates new money. What new money is created on €5000, if 8% is earned? €5000 (1 + 0.08) = €5400 €5000 €400 Original Lump Sum New Money. What about next year?. What new money is created on € 5400 , if 8% is earned? €5400 (1 + 0.08) = €5832

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The Power of Compounding

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  1. The Power of Compounding

  2. Compounding creates new money.. What new money is created on €5000, if 8% is earned? €5000 (1 + 0.08) = €5400 €5000 €400 Original Lump Sum New Money

  3. What about next year? What new money is created on €5400, if 8% is earned? €5400 (1 + 0.08) = €5832 €832 €5000 Original Lump Sum €400 €432 (Yr 1) (Yr 2)

  4. Where are we in five years? • €5000 ( 1 + 0.08) = €5400 • €5400 ( 1 + 0.08) = €5832 • €5832 ( 1 + 0.08) = €6298 • €6298 ( 1 + 0.08) = €6802 • €6298 ( 1 + 0.08) = €7346

  5. How long will it take to double my money? Rule of 72 72 = How many years it takes Interest Rate to double your money 72 = 9 years 8

  6. Is there a faster way to work it out than this? • €5000 ( 1 + 0.08) = €5400 • €5400 ( 1 + 0.08) = €5832 • €5832 ( 1 + 0.08) = €6298 • €6298 ( 1 + 0.08) = €6802 • €6802 ( 1 + 0.08) = €7346 …………………….

  7. Yes! no of years Principal (1 + interest rate/100)^ (One plus the interest rate) to the power of (the number of years) multiplied by (the principal)

  8. Example – where are we in five years? The long way… €6802 ( 1 + 0.08) = €7346 The short way… €5000 * (1.08)^5 = €7346

  9. How does this apply to real life? Take a person who starts saving €3000 per year from the ago of 22. She puts away the money into a high interest account earning 6% How much does she have when she turns 65? €674,186.99!!!

  10. Could you put a price on Manhattan? • In 1626, the natives in New York traded Manhattan for $24 worth of glass beads. • Do you think that was a good deal? • Who got the better deal?

  11. Who got the better deal? • If the Americans had put that $24 on deposit at 6% interest in 1626… • They could buy Manhattan today… • TWICE OVER… • SKYSCRAPERS AND ALL… • AND have $1 billion left over in spare “change”

  12. Now, think about how the expenses impact Transaction Costs and Taxes

  13. Remember the lady that put away €3000 per year… • Imagine, if each year, 5% of her portfolio was taken away in transaction costs. • By the time she would have arrived to 65, 5% of the portfolio was worth… • €674,186.99 * 5% = €33709

  14. What if you could reduce that to 1%?€674,186.99 * 1% = €6741

  15. What is her saving? €26968 The price of a VERY NICE new car…

  16. Taxes • Currently, the government charge 25% of any gains over and above €1270. • The impact of transaction costs is enough to prove to you the difference expenses can make over time • What if you could legally avoid paying tax?

  17. How do you avoid paying tax on your gains… legally? • Put the money into a pension! • All a pension does is put a wrapper around your investments that prevents the tax office from taking some out of it. • Also, it stops you from going on a spending spree, as it is tied up there until you retire

  18. Are they not just for the elderly? Not at all, instead of spending all your money now, you simply put some away, let it grow and live more comfortably and enjoy life all the more when you do retire.

  19. The Point Is To Start As Soon As You Can

  20. In real life… Carry out these three exercises to find the answers using the “short cut” formula. no of years Principal (1 + interest rate/100)^

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