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Very few people are wealthy. This seems like an obvious statement, yet consider these statistics. Out of 100 men today aged 20, by the time they reach 65, 64 will rely on the state or family for their everyday needs, nine will get by on their own resources, one will be wealthy and 26 will be dead

 

But many more could be much richer by applying the five laws of compounding to their
investment strategy. Instead, many go through life relying on luck or the prospect of a
possible inheritance to realise their dreams.

 

 

 

A graduate leaving full-time education at the age of 21 can expect to earn about £20,000
in their first job. Just average career progression, and a modest inflation rate, will give
them career earnings well over £3 million by the time they reach 60. Yet too many people
are still not wealthy by this age. Like any goal, becoming wealthy takes serious discipline.

 

There are five laws of compounding that work in the favour of any investor. They cannot
be compromised and ignoring them leaves you relying on luck. Sticking to them makes
wealth creation nothing short of a certainty. The Laws of Compounding are based on
sound mathematics and should be obeyed without question for anyone with the serious
goal of personal wealth creation
.  

 

Law 1 Start Early

 

Winston and Lloyd are twins. Winston decides to save £500 a month from his salary at
20. The investment gives a 14% annual return and after 10 years he decides to stop his
payments but allows his money to continue growing. Lloyd on the other hand delays his
decision to invest until he is 30, however he continues to hold his investment until he
retires. The table below shows the impact of both strategies.

Extraordinary isnt it? By the time they reach 60, Winston is still almost three times
wealthier than Lloyd even though he hasnt contributed to his savings for 30 years!

 

Law 2 Small Differences Matter
 

Small differences in investment returns really matter. Two or three percent doesnt sound
like it could affect the investment dramatically but it does. Winston and Lloyd have two
friends, Pat and Linda. They are the same age as Winston and Lloyd and save their money
in the same way. Winston starting saving at age 20 and Linda at age 30, with £500 a
month. Unfortunately they were not as astute as Winston and Lloyd with their choice of
investments and so only made an 11% return. The table shows how much they ended up with.

 

 

As time goes by Pat and Lindas investments pale into insignificance compared with those
of Winston and Lloyd. Winston ends up retiring with 261% more capital than Pat even
though he adopted the same savings pattern.

 

Law 3 Avoid the Taxman

 

Most people don't understand the enormous impact taxation can have on their wealth-building strategy. Even some of those who do don't realise there are legal tax-efficient methods of protecting capital.

Take £1.00 and double it every year for 20 years. You may be astounded to realise, that such consistent investment performance will reward you at the end of the term with a useful £1,048,576 to spend. 
 

£1 doubled for 20 years  £1,048,576

Such is the beauty of compound growth. But then of course, the tax office will ask for their share. Let's say their demand is reasonable and they asked for 20%. The table below shows the impact. Over 20 years your cool million has been devastated! 
 

20% Tax       £127,482
40% Tax         £12,089

A 40% pa growth tax on your investment will leave you with just over 1% of your investment potential. Of course the example isn't realistic, because nowhere in the world is it possible to sustain a doubling of your investment consistently over 20 years. The table above however, is designed to impress upon you the simple fact, that even relatively low taxation of a high performance portfolio has a tremendous impact over time. 
 

 

Law 4 Give your investment time

 

Maybe now you are starting to dream about how you can acquire astonishing sums of
money by investing profitably in the future. An implication of Law No 1 is that you must
give your investment plenty of time. It really is that simple, you almost certainly can
become very wealthy by investing in this way. Beware however of Law No 5...

 

Law 5 Dont spend all your capital

 

It is all too easy to be tempted by excessive consumerism. New cars, more exotic holidays,
larger houses can all drain your investment potential. It is essential to stand back and assess the facts before spending your money too soon. Let us consider what happens to Winston?s capital over the long term if he decides to use £25,000 to buy a new car at the age of 26.

By this age, because Lloyd has had the good sense to invest early he has about £55,000
to spend. But his investment prowess will be shattered by his decision to spend his capital.
By the time he retires he will have waived goodbye to A£2,150,000. Assuming inflation at
4%, if he kept his £25,000 invested he would save enough cash to buy 20 cars on retirement.

 

Summary

 

It isnt difficult to understand why most people arent wealthy. The average investor has
no structure to their savings. They start too late and add to their investment irregularly.
They choose investments that perform badly, submit to a high tax environment and dip
into their nest egg to satisfy their short-term consumerism. These pitfalls can be avoided,
or at least mitigated, with sound professional advice.

Temple Bar International is an investment broker dedicated entirely to the expatriate. We have regular saving solutions to help our clients plan for retirement, school fees, major purchases or any other medium to long term goal.

* Source: British Civil Service Statistical Review 2000

 


 

 

Very few people are wealthy. This seems like an obvious statement, yet consider these statistics. Out of 100 men today aged 20, by the time they reach 65, 64 will rely on the state or family for their everyday needs, nine will get by on their own resources, one will be wealthy and 26 will be dead