Banks in Hong Kong offer incredibly low interest rates on our deposits – they are nowhere near enough to beat inflation. For example, one of Hong Kong’s major banks gives interest of just 0.125% for HK$5,000 and above. In 2018, the average prices of goods in Hong Kong rose by 2.4%, with the long-term average at 4.3%.
Essentially, money in the bank is getting eaten away by the inflation monster each and every year. Our hard-earned money is far from “safe” in the bank. Therefore, all of us need to learn to invest to at least retire comfortably. And we all know that we cannot rely on the local MPF system to provide adequately for us in retirement. So, the longer you invest, the longer your money has to work its magic (read: long-term investing).
The eighth wonder of the world
World-famous scientist, Albert Einstein, once quipped that compound interest is the eighth wonder of the world. Compound interest is the interest that accumulates on the initial principal and the accrued interest thereafter. Compound interest allows a principal amount to grow at a quicker rate than simple interest.
A beauty of compound interest is that the longer and earlier you invest, the stronger your money will compound. One of the Dow Theory Letters, entitled Rich Man, Poor Man, talked about the benefits of compounding our money over the long-term with an example.
Say there are two people, Investor A and Investor B. Investor A starts investing at the age of 19. He invests $2,000 every year from age 19 until 25 and stops thereafter. That means he has put $14,000 into his stock portfolio.
On the other hand, Investor B starts investing only at the age of 26. From age 26 until 65, he invests $2,000 annually in stocks. By the time he turns 65, he has contributed $80,000 to his portfolio.
Assuming both investors can generate 10% yearly on their portfolios, whose portfolio would be larger at age 65? Most would think that Investor B would have a bigger portfolio. Yes, Investor B indeed has the larger portfolio at $973,704 while Investor A’s portfolio would be worth $944,641. However, here’s the kicker.
Investor A wins overall as he has higher net earnings of $930,641 versus Investor B’s $893,704. Remember that Investor A had only put in $14,000 over seven years, while B contributed $80,000 over 40 years.
The Dow Theory mentioned the following about compounding (emphases are mine):
“Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why.
And you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compounding road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.”
Time helps to accelerate the growth of our money. The following is the formula for compound interest:
FV = PV × (1+r)n
where FV = Future Value; PV = Present Value; r = annual interest rate; n = number of periods
As seen, the longer the period, n, the more compounding can occur, creating a larger ending amount, FV. This is also why everyone should start investing at a very young age for the power of compounding to take effect.
A top investing idea
So, what can we do to grow our money and beat inflation at the same time?
For a start, you can look into buying the Tracker Fund of Hong Kong (HKG: 2800), an exchange-traded fund (ETF) that tracks the performance of the Hong Kong broad market, Hang Seng Index. Some of the big names included in the ETF are AIA Group Ltd (HKG: 1299), Tencent Holdings Ltd (HKG: 0700), and HSBC Holdings plc (HKG: 0005). Apart from the three companies, there are 47 other companies in the ETF, allowing for instant diversification.
In the past three years up till 30 June 2019, excluding dividends, the ETF has produced a return of 11.1% per annum. Including dividends, the return would be much higher; as of 12 July 2019, the dividend yield of the ETF was 3.2%. Not only has the Tracker Fund of Hong Kong beaten inflation nicely but it also gives regular income, in the form of dividends, to investors.
Three common investing pitfalls to avoid
Here are some common mistakes people make when it comes to investing:
- Waiting for the right time to invest. There is never a right time to invest. The best time to invest is now. Time in the market is more important than timing the market.
- Investing for the short term. As seen earlier, for compounding to take effect, we need time to do its thing. Businesses take time to grow. Going in and out of the market will only hurt our portfolio returns.
- Investing money you require in the next few years. We should only invest capital we do not need in the next five years at least. In that way, we will not be emotionally affected when the stock market turns negative.
Investing is not reserved for the elite few. Everyone should start investing to prevent inflation from eating our money away. Here at The Motley Fool Hong Kong, we strongly advocate long-term investing as it allows the effects of compounding to take place. And the best time to invest is: right now.