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A couple of months back I spent the good part of a weekend binge-watching The Queen’s Gambit on Netflix, and found myself thinking of an old fable which illustrates the role that time plays in investing.
Legend has it there was an Indian King who was obsessed with chess. The King held his own skills in rather high regard, and often bested the scholars in his realm in friendly matches.
Whenever a new traveller entered his kingdom, he would challenge them to a game, and if they beat him, he would reward them with any treasure or prize they desired.
One day a pilgrim wandered into his land and was challenged to a game by the King. What the King didn’t know is that our pilgrim friend was actually a chess grandmaster and had been playing his whole life. When asked his terms, he modestly requested: “Your Highness I would simply like a single grain of rice for the first square and then for each corresponding square to double the last”. The king laughed and agreed to these measly terms.
The pilgrim went on to beat the king in impressive fashion and left the crowd gob-smacked. However, although stunned, the King stayed true to his promise and acknowledged that the pilgrim’s reward would be met.
The King’s servants began placing grains of rice upon the chess board – one in the first square, two in the second, four in the third, eight in the fourth and so on.
It didn’t take the King long to realise that he may have bitten off a little more than he could chew. He calculated that by the 30th square he would be required to put down 1 billion grains of rice, and by the 64th and final square he would need to reward the pilgrim with roughly 18,000,000,000,000,000,000 grains (that’s eighteen quintillion for those playing at home). That is about 210 billion tons of rice, the same as around 10.5 million sphinxes of Egypt – or enough to cover the whole of modern-day India in a one metre thick layer of rice.
The pilgrim, being the kind and understanding individual that he was, acknowledged that it was a ridiculously large amount of rice and agreed that the king could pay it off annually, and even pay him in other assets like gold or land.
What does this fable teach us?
Well, clearly that chess is very profitable, or maybe that our pilgrim had a hankering for risotto.
In reality, the story teaches us about the power of accumulation over time – perhaps better known as ‘compounding’.
What is compounding?
Compounding is one of the fundamental components of wealth creation and is nothing new to fund managers, stockbrokers or financial advisers. Think of it as a self-fulfilling cycle, where your investment earns interest, and then your interest earns interest, creating a snowball effect!
As Albert Einstein once said: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Essentially, compounding means that your wealth can grow faster over time, because you are not only getting returns on your initial investment, you are also getting returns on your returns.
Why is this particularly important to the millennial investor?
Well, my avocado-obsessed brethren… it’s important because the main ingredient to this dish is time – something that we millennials have a lot of.
While any investor can take advantage of compounding, the greatest benefit goes to those who get started early. The best way to explain this is through a simple case study.
Source: BetaShares. Hypothetical example provided for illustrative purposes only. Past performance is not indicative of future performance. Not a recommendation to make any investment or adopt any investment strategy.
As you can see in the hypothetical above – delaying the start of your investment journey by 10 years could make quite the difference in the world of compounding.
Holly has only contributed $12,000 more to her investing ‘pot’ (10 years x 12 months x $100) – but ends up with more than double Ben’s final nest egg.
So while it may be hard to find the cash when you’re young and there are more interesting things to spend your hard-earned on, making the effort to start investing early could make a massive difference later on.
So, how do I get started?
You already have.
For most Aussies, superannuation is our first introduction to forced saving. On top of that it’s also our first introduction to investing – and compounding.
If you want to take further advantage of compound returns and accelerate your wealth accumulation, one way to do that is to make additional contributions to super, either by salary sacrificing or by making non-concessional contributions.
Another way to take advantage of compounding returns is through investing in ETFs. While ETFs don’t offer the tax advantages of super, you have access to your funds and won’t be locking them away.
ETFs enable you to align your investments with your beliefs and interests – whether that means placing your money in ethical ETFs such as the BetaShares Global Sustainability Leaders ETF (ETHI), or obtaining technology focussed exposure via funds such as the BetaShares NASDAQ 100 ETF (NDQ), which holds names like Apple, Microsoft and Facebook.
Another benefit of an ETF is the ability to elect into a Distribution Reinvestment Plans (DRP) – whereby your distributions (which are made up largely of dividends) are automatically reinvested into the fund with no additional brokerage. This means earnings are retained within your investment and will contribute to the growth of your portfolio over time, and you save on transaction costs over time.
Using ETFs means that you can not only invest in the market segments that interest you – but also put that sweet, sweet compounding to work.
Focusing on the benefits of compounding is essential to the art of long-term investment. Get started early, stay consistent with your investments and contributions – over time your worth can be expected to increase, and you’ll have all the rice you desire!