Don’t fall victim to the dark side of compounding

Yes. I’m talking about compounding – Widely regarded as the key to successful investing.

Famous investors like Warren Buffett, Charlie Munger, and Peter Lynch call it the most POWERFUL force behind their investment fortunes!

But BEWARE… There’s another side to compounding you must consider… One that can destroy your wealth and put your retirement in danger!

Here’s what I’m talking about…

“He who understands it, earns it … he who doesn’t … pays it.”

This is a quote supposedly made by Albert Einstein on compound interest. Whether he said it or not, that’s not important…. What is important is it accurately highlights the “dark” side of compound interest.

If you’re not earning it through saving or investing, you’re most likely paying it. The more you pay it, the more your wealth erodes.

So when can compounding work against you?

Don’t fall victim to high interest “Debt-Traps”

According to a TransUnion report, more and more South Africans are applying for personal loans, retail revolving loans and credit cards to help their short-term cash flow.

And each one of these credit products come with a massive interest charge! I’m talking about rates as high as 18%, 20%, 25% or more in interest on your store credit card or loans.

Now, compare that to the interest you could generate by saving, which is around 8%-9% today.

Simply put – you pay MORE THAN DOUBLE the interest on debt than what you would receive from saving.

This interest “negatively” compounds so it makes your debt grow quicker and more substantially over time. As a result the balance can end up larger than the amount you initially borrowed!

Don’t let your retirement investments work against you – A R2,500 monthly investment could cost you R1 million in fees!

When you’re saving for retirement or another big financial goal, every cent counts. So you need to negotiate all your fees – it’s easy to miss them. I’m talking about brokerage fees, advisor fees and fund expense ratios — which can add up to a lot more than you realise, thanks to what’s called “negative compounding”.

Let’s say you invest in a Retirement Annuity (RA). You appoint a financial advisor to handle your investment and
hope they invest it wisely in funds that can generate you the best return.

Doing this, means you’ll have to pay fees.

1. Your financial advisor fee.
2. If they oversee your portfolio, you can pay an annual advice fee too.
3. The fund/s your money is invested in charge a fee.

There’s no escaping this – every fund – whether it’s equities, bonds, money market etc – charge a fee.

And they all differ.

Let’s say you invest R2,500 a month for 30 years and generate a 10% return ever year.

But you also pay 2% in fees.

Here’s how the dark side of compounding can eat away your returns…

In year one, you’ll pay around R660 in fees…

By year 10, you’ll pay R10,674 in fees…

By year 20, that rises to R38,205…

And by year 30, you’ll pay over R109,000.

In total, you would’ve paid over R1 million in fees. That equals to nearly 20% of your returns – gone
towards fees!

If you’re looking for ways to avoid this and find better returns, then you’ll find the answers to growing and protecting your wealth by joining my Real Wealth community. You can learn more about us here.