Compounding, the 8th wonder of the world.

 Compounding, the 8th wonder of the world.

Elaboration of Section 28

This section is dedicated to the single most powerful force in investing: Compound Interest. It is described as the "8th wonder of the world" (a quote often attributed to Einstein), and for good reason. This section illustrates how compounding transforms disciplined saving and time into extraordinary wealth.

1. The Core Mechanism: Earning Returns on Your Returns
Compounding is the process where the earnings generated by an investment themselves generate their own earnings.

• Without Compounding (Simple Interest): You earn returns only on your original principal.

• With Compounding: You earn returns on your original principal plus all the accumulated earnings from previous periods. This creates a snowball effect where growth accelerates dramatically over time.

2. The Mathematical Magic: The Rule of 72
The section introduces the "Rule of 72," a simple formula to estimate the power of compounding:

• Formula: 72 ÷ Annual Interest Rate = Number of years to double your money.

• Examples:

  • At 4%, your money doubles every 18 years (72/4).

  • At 12%, it doubles every 6 years (72/12).

  • At 15%, it doubles every 4.8 years (72/15). This shows why the 15% target from earlier sections is so powerful.

3. The Two Most Critical Ingredients: Rate and Time
The section uses powerful stories to show that compounding requires both a good rate of return and, most importantly, a very long time horizon.

• The Story of Anne Scheiber (Revisited): She started seriously at age 51. By living to 101 and compounding at 15%, her wealth grew exponentially. The retrospective calculation shows that her $22 million fortune was built from a relatively modest sum that doubled again and again over 50 years.

• The Story of Warren Buffett: The section makes a stunning point: 95% of Buffett's wealth was built after his 50th birthday. His skill was the catalyst, but the time he has been investing (over seven decades) provided the fuel for compounding to work its magic on a massive scale. This demonstrates that the biggest gains occur in the later years.

4. The Ultimate Lesson: Start Early and Be Patient
The section hammers home two key messages:

• For the Young: The earlier you start, the less you need to save. The story of Michael vs. Terrence shows that someone who saves for only 10 years early in life can end up with more than someone who saves larger amounts for 25 years starting a decade later.

• For Retirees (The "Oldies"): It's not too late. While the gains won't be as astronomical as Buffett's, the principle still applies. Consistent compounding at a reasonable rate is the most reliable way to grow and protect wealth, even in one's 50s, 60s, and beyond.

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Summary of Section 28

Section 28 explains that compound interest—earning returns on your returns—is the most powerful force for building wealth, and its effectiveness is determined by the rate of return and, most critically, the length of time invested.

• The "8th Wonder": Compound interest has a snowball effect, where growth accelerates over time, leading to exponential results.

• The Rule of 72: A simple formula to see how long it will take to double your money at a given interest rate.

• The Critical Ingredient is Time: The most significant growth happens in the later years. This is why starting early is paramount, as demonstrated by the fact that the vast majority of Warren Buffett's wealth was built after age 50.

• The Practical Implication: The key to harnessing this power is to start as early as possible, invest consistently, and hold for the very long term, allowing the mathematical inevitability of compounding to work in your favor.

In essence, this section provides the "why" behind the entire long-term, buy-and-hold philosophy promoted throughout this set of notes. It shows that investing success is not about getting rich quickly through speculation, but about getting rich surely through the patient and disciplined application of a mathematical certainty.

Reinvestment risk

An old post discussing reinvestment risks posted in May 16, 2017.  Data of Aeon Credit then was unadjusted for capital changes that have occurred since.


http://www.investlah.com/forum/index.php/topic,78077.msg1522231.html#msg1522231

Aeon Credit  May 16, 2017

FY                      HPr      LPr      adjDPS (sen)

28-Feb-17       18.06     12.94       63
29-Feb-16       15.62     11.92       63.23
20-Feb-15       14.86     11.00       28.22
20-Feb-14       18.00     10.30       46.3
20-Feb-13       18.86     10.38       32.15
20-Feb-12       13.72       5.50      25
20-Feb-11         5.75       3.09      22.08
20-Feb-10         3.48       3.02      18.75

 May 16, 2017
The price of Aeon Credit peaked in 2013. After then, it went on a decline.

I remembered discussing this company with fellow forum participant, cockcroach (who has since disappeared, hopefully temporarily).

Cockcroach sold his Aeon Credit around 16.00 per share.#




After selling a share at a certain price, when can we say we have made a profit from the sale?

For those who are long term invested into stocks, what do they do with the cash from the sale?

1. By selling a share at a certain price, have I made a profit?

Yes, since I bought the stock at a lower price in the past.

No, since I bought the stock at a higher price in the past.



2. What would you do with the cash from the sale?

I am out of the market, forever. In that case, you would have realised a gain or a loss, which is definite.

I am in the market for the long run. I would have to reinvest this cash into another stock or the same stock.



3. When would you have realised a gain, after selling a stock, if you were to be in the market for the long term?

I would have realised a gain, IF I am able to buy the same stock back at a lower price than I sold.

I would have realised a loss, IF I were to buy the same stock back at a higher price than I sold.

I would have also to take into account the dividends I did not receive (if any) while I was holding cash and out of the stock for that period.



4. Can you predict the short term volatility of the share prices of your stock?

I believe I cannot. Those who can, are either having uncanny abilities or are lying.





AEONCR November 03, 2017
Price 14.30
Market Capital (RM): 3.536b
Number of Share: 247.25m
EPS (cent): 119.03 *
P/E Ratio: 12.01
ROE (%): 24.54
Dividend (cent): 63.000 ^
Dividend Yield (%): 4.41
Dividend Policy (%): 0
NTA (RM): 4.850
Par Value (RM): 0.500

Price of 14.30 above is equivalent to 14.10 today when adjusted for capital changes.

AEONCR 27.1.2019
Price 15.98
Market Capital (RM): 4.007b
Number of Share: 250.78m
EPS (cent): 139.29 *
P/E Ratio: 11.47
ROE (%): 24.61
Dividend (cent): 41.130 ^
Dividend Yield (%): 2.57
Dividend Policy (%): 0
NTA (RM): 5.660
Par Value (RM): 0.500


Since Nov 2017, the share price of Aeon Credit has gained 13.3% (15.98/14/10 = 113%), excluding dividends received.


#(16.00 per share is equivalent to 15.78 per share today, adjusted for capital changes.)

Which is Better: Dollars in the Hand or "in the Bush"?

Professional investment managers strongly favour corporations which can plow back a high percentage of earnings into growing their business.

Does this always pay?

Or should the investor prefer his dividends?

For every example of a company that has compounded its growth by wise investment of its cash there are several that would have done better to pass their surplus on to their stockholders.

Very rarely, one finds a management that can do both.

• For example:  Company XYZ paid out almost 70% of its earnings in dividends.  It has invested its cash flow internally to maximum advantage.  Its shareholders have had their cake and eaten it too.

Expected Profits

The normal way for management to look upon proposed investments is to estimate the expected amount of profit.

This varies from industry to industry.

In any case,it would be unreasonable to invest company funds unless the expected return was substantial.

One finds far too much reinvestment that fails to pay off.

It is difficult for management to understand that in some cases stockholders are paid off better with their company dead than alive.




Examine the past record.

Correct judgement of management policy can only come from a full understanding of the problems involved.

It will pay the investor well to look beyond the superficialities of figures showing totals put back into business by management.  

Consideration should be given to the past record.

How have plow-back expenditures actually turned out?




There is no hard-and-fast rule.

Some stockholders profited enormously by management spending.

Other stockholders suffered through management hoarding.

Many unwise investments were made by corporate management at the wrong time.

Some very wise one were made at the right time.

This is an often overlooked factor which you should include in your analysis of stocks to buy.

The Sources of Risk in Stock Investing

Total Risk = Unsystematic Risk + Systematic Risk

Unsystematic Risk (diversifiable)
Business Risk
Financial Risk

Systematic Risk (nondiversifiable)
Market Risk
Interest Rate Risk
Reinvestment Rate Risk
Purchasing Power Risk
Exchange Rate Risk

Reinvestment Risk

Definition of 'Reinvestment Risk'

The risk that future coupons from a bond will not be reinvested at the prevailing interest rate when the bond was initially purchased.

• Reinvestment risk is more likely when interest rates are declining.
• Reinvestment risk affects the yield-to-maturity of a bond, which is calculated on the premise that all future coupon payments will be reinvested at the interest rate in effect when the bond was first purchased. 
• Zero coupon bonds are the only fixed-income instruments to have no reinvestment risk, since they have no interim coupon payments.  

Investopedia explains 'Reinvestment Risk'

Two factors that have a bearing on the degree of reinvestment risk are:

• Maturity of the bond - The longer the maturity of the bond, the higher the likelihood that interest rates will be lower than they were at the time of the bond purchase.
• Interest rate on the bond - The higher the interest rate, the bigger the coupon payments that have to be reinvested, and consequently the reinvestment risk.

Read more: http://www.investopedia.com/terms/r/reinvestmentrisk.asp#ixzz1yNSI15fi

The Risks of Bond Investing: Understanding Dangers in Fixed-Income Investing

There's no such thing as a sure thing, even in the bond world

From Paul Conley, former About.com Guide

Bonds are among the safest investments in the world. But that hardly means that they’re risk free. Here’s a look at some of the dangers inherent in fixed-income investing.

• Inflation Risk: Because of their relative safety, bonds tend not to offer extraordinarily high returns. That makes them particularly vulnerable when inflation rises.
  Imagine, for example, that you buy a Treasury bond that pays interest of 3.32%. That’s about as safe an investment as you can find. As long as you hold the bond until maturity and the U.S. government doesn’t collapse, nothing can go wrong….unless inflation climbs. If the rate of inflation rises to, say, 4 percent, your investment is not “keeping up with inflation.” In fact, you’d be “losing” money because the value of the cash you invested in the bond is declining. You’ll get your principal back when the bond matures, but it will be worth less.
  Note: there are exceptions to this rule. For example, the Treasury Department also sells an investment vehicle called Treasury Inflation-Protected Securities.
• Interest rate risk: Bond prices have an inverse relationship to interest rates. When one rises, the other falls.
  If you have to sell a bond before it matures, the price you can fetch will be based on the interest rate environment at the time of the sale. In other words, if rates have risen since you “locked in” your return, the price of the security will fall.
  All bonds fluctuate with interest rates. Calculating the vulnerability of any individual bond to a rate shift involves an enormously complex concept called duration. But average investors need to know only two things about interest rate risk.
  First, if you hold a security until maturity, interest rate risk is not a factor. You’ll get back the entire principal upon maturity.
  Second, zero-coupon investments, which make all their interest payments when the bond matures, are the most vulnerable to interest rate swings.
• Default Risk: A bond is nothing more than a promise to repay the debt holder. And promises are made to be broken. Corporations go bankrupt. Cities and states default on muni bonds. Things happen...and default is the worst thing that can happen to a bondholder.
  There are two things to remember about default risk.
  First, you don’t need to weigh the risk yourself. Credit ratings agencies such as Moody’s do that. In fact, bond credit ratings are nothing more than a default scale. Junk bonds, which have the highest default risk, are at the bottom of the scale. Aaa rated corporate debt, where default is seen as extremely unlikely, is at the top.
  Second, if you’re buying U.S. government debt, your default risk is nonexistent. The debt issues sold by the Treasury Department are guaranteed by the full faith and credit of the federal government. It’s inconceivable that the folks who actually print the money will default on their debt.
• Downgrade Risk: Sometimes you buy a bond with a high rating, only to find that Wall Street later sours on the issue. That’s downgrade risk.
  If the credit rating agencies such as Standard & Poor’s and Moody’s lower their ratings on a bond, the price of those bonds will fall. That can hurt an investor who has to sell a bond before maturity. And downgrade risk is complicated by the next item on the list, liquidity risk.
• Liquidity risk: The market for bonds is considerable thinner than for stock. The simple truth is that when a bond is sold on the secondary market, there’s not always a buyer. Liquidity risk describes the danger that when you need to sell a bond, you won’t be able to.
  Liquidity risk is nonexistent for government debt. And shares in a bond fund can always be sold.
  But if you hold any other type of debt, you may find it difficult to sell.
• Reinvestment Risk: Many corporate bonds are callable. What that means is that the bond issuer reserves the right to “call” the bond before maturity and pay off the debt. That can lead to reinvestment risk.
  Issuers tend to call bonds when interest rates fall. That can be a disaster for an investor who thought he had locked in an interest rate and a level of safety.
  For example, suppose you had a nice, safe Aaa-rated corporate bond that paid you 4% a year. Then rates fall to $2%. Your bond gets called. You’ll get back your principal, but you won’t be able to find a new, comparable bond in which to invest that principal. If rates have fallen to 2%, you’re not going to get 4% with a nice, safe new Aaa-rated bond.
• Rip-off Risk: Finally, in the bond market there’s always the risk of getting ripped off. Unlike the stock market, where prices and transactions are transparent, most of the bond market remains a dark hole.
  There are exceptions. And average investors should stick to doing business in those areas. For example, the bond fund world is pretty transparent. It only takes a tiny bit of research to determine if there is a load (sales commission) on a fund. And it only takes another few seconds to determine if that load is something you’re willing to pay.
  Buying government debt is a low-risk activity as long as you deal with the government itself or some other reputable institution. Even buying new issues of corporate or muni debt isn’t all that bad.
  But the secondary market for individual bonds is no place for smaller investors. Things are better than they once were. The TRACE (Trade Reporting and Compliance Engine) system has done wonders to provide individual bond investors with the information they need to make informed investing decisions.
  But you’d be hard-pressed to find any scrupulous financial advisor who would recommend that your average investor venture in to the secondary market on his own.
  
  
  http://bonds.about.com/od/bonds101/a/bondrisk.htm