Your Best Investment Strategy

image: investopedia.com

Your biggest investment loss is the money you never spent on investment.
 
 There is a popular “Where’s your Ferrari joke” that goes as follows — 
 
Lady: Do you smoke?
 Guy: Yes I do.
 Lady: How many packs a day?
 Guy: 3 packs.
 Lady: How much per pack?
 Guy: $10.00 per pack.
 Lady: And how long have you been smoking?
 Guy: 15 years
 Lady: So 1 pack is $10.00 and you have been smoking 3 packs a day which puts your spending per month at $900. In 1 year, it would have been $10,800. Correct?
 Guy: Correct.
 Lady: If 1 year you spend $10,800, not accounting for inflation, the past 15 years puts your spending total at $162,000. Correct?
 Guy: Correct.
 Lady: Do you know if you hadn’t smoke, that money could have been put in a step-up interest savings account and after accounting for compound interest for the past 15 years, you could have by now bought a Ferrari?
 Guy: Oh. Do you smoke?
 Lady: No.
 Guy: Then where’s your f** Ferrari?
 
 If you’ve done any significant digging into the investment world and how to max out your investment gains, you would, no doubt, have come across the magic of compounding and the miracle of having a savings habit. 
 
 It’s not uncommon to see analysis like — 
 “If you started at age 25 saving NGN10,000 a month at an annual rate of 12% for 40 years vs if you waited till you’re 39 saving NGN20,000 a month at same annual rate of 12% for 26 years; at age 65 you will end up with NGN122 million in the first case and NGN44 million in the second case despite contribution more in absolute terms in the second case. You would have saved NGN4.8 million (NGN10,000 x 12 months x 40 years) in the first case vs NGN6.24 (N20,000 x 12 months x 26 years) in the second case, yet you would be a lot less richer, by NGN 80 million, in the second case.”
 
 That is the magic of compounding interest when you start early!
 
 So when you think your money is too small and you are too young to focus on saving/investing, you might be incurring your greatest investment loss. Just starting early in itself can make you way richer in the end than starting with a larger sum later in life.
 
 The problem is that our brain is not naturally good at handling delayed gratification and grasping the magic of compound interest of years. It is a lot easier to spend your extra NGN90,000 on a new iPhone than go put it in an investment account when you are 25 years old. You can’t easy comprehend that the N90,000 at 12% annual rate will ultimately become NGN11 million in 40 years. Even if someone shows you the calculation you will still find it a lot easier to dismiss than do, thinking who wants to wait 40 years. And then the 40 years will come and that seed opportunity is forever lost and you are NGN11 million less rich.
 
 Like the Ferrari joke, we are quick to dismiss all the analysis. It is a lot easier to see the people not doing it (our friends and family) than see the people who earned the bulk of their wealth from the magic of compound interest (like Warren Buffett).
 
 So what is your best investment strategy?
 
 In case it has not become clear to you from my illustrations: it is that you should start with whatever you can right now and make investing a habit. And as long as you are not stupid enough to make really really bad investment choices, you will end up a lot lot richer in the end for it.


Originally published at www.olafusimichael.com.