There’s a popular Chinese proverb that says: “The best time to plant a tree was 20 years ago. The second-best time is now.” This is used to show the amazing power of compound interest. Is it a diversified investment strategy to use for your financial goals?
The expression is often used in some personal finance circles about investing in the markets. The premise is this. For those who want investment or financial success the best time to act is now. Even though it was probably better to act sooner.
This is because of the effect of compound interest. Compound interest was called the eighth wonder of the world by Albert Einstein because. This is because it allows you to earn interest on your interest. Practically speaking this means that a 20-year-old can invest less aggressively compared to a 40-year-old to reach the goal of £1 million. This is assuming they both have the financial goal to retire at 65.
Life is about the journey
However, personal finance 101 does not take into account individual circumstances or different personalities. At one extreme some young people have economically savvy parents. These people have family members who discuss personal finance, business. They are able to give their children a strong fiscal start in their life journey. At the other extreme, some people start their adulthood in debt due to not understanding consumer debt or graduating with student loans.
Life is not as easy or as straight forward as maths, economics or finance. Life is about the journey. The bit in between the best time and the second-best time. From my observations, it is not a straight forward path. Rather for many, it is a series of realisations, experiences and observations about who we are and what we want to experience and become and having a roadmap to get there.
Maybe life isn’t about understanding the wonders of compound interest at 20 years of age. Though it puts you at an advantage if you do and you take action. Maybe understanding and gaining wisdom from not understanding compound interest at a young age is the journey you need to go on to have a financially steady and fulfilling life.
Maybe going into consumer debt is a great lesson for a 20-year-old to have so they understand how a £100 purchase could easily result in a £1000 debt. If you don’t pay this could result in bailiffs demanding payment. It could also be a lesson you need to learn so that you can understand why you spend the way that you do. This could be for emotional reasons like to seek approval from others or a salve for pain.
A failed business may result in a successful business as you learnt what went wrong the first time. Using your life savings to go travelling could create many ideas, including money-making ones, as well as broadening your social circle or horizons. It could result in a long love affair with learning a particular language.
The point I am trying to make is this. Having a financial cushion is important but I would argue developing and having the emotional intelligence to create happy and harmonious relationships is equally important.
Life throws many curveballs for each of us and having the skills and emotional know how to resolve problems is a very useful skill that will enable you to develop the knowledge to achieve your financial goals.
The Millionaire Fastlane
In his book, The Millionaire Fastlane M. J. DeMarco argues the concept of compound interest as a way of achieving financial wealth is flawed. He states: “Wealth acceleration via compound interest is deficient because its variable is deficient.” The variables he refers to here are returns from financial markets and the economy.
There are also many examples of entrepreneurs who have reached their financial goals within a relatively short time period:
- Jen Sincero writer of the Badass series of books didn’t start her path to financial freedom until she was in her 40s
- Colonel Harland Sanders founded KFC when he was 65 and within 8 years sold the company for millions
- Ali Abadall a doctor from Cambridge started a YouTube channel in 2017. He has amassed more than a million subscribers and in 2020 the channel generated a million in revenue
Compound interest is an important part of an investment strategy. It does NOT create and generate wealth FAST. Tech Buddha, Naval Ravikan, states: “You are not going to get rich renting out your time. You must own equity, a piece of the business to gain your financial freedom.” This is also a point made by M. J. DeMarco. They both point out creating and developing your own business is the best and fastest way to generate wealth and capital.