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Magical Penny versus Magic of Compound Interest

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silver and gold coins

Photo by Pixabay on Pexels.com

One simple financial question to ask yourself and colleagues:

“If you had a choice, would you rather receive $200,000 cash or a penny that doubles in value every day?”

Not surprisingly, most people choose the $200,000.  It is the bird in the hand concept.

But in reality, the magical penny would actually leave individuals much better off. Due to the magic of compound interest, a penny that doubles in value every day would be worth more than $10 million after only a month!

The compound interest equation which follows applies:

FV = PV(1+r)n, where FV is future value, PV is present value, r is the interest rate per period, and n is the number of compounding periods.

Compounding is the effect where an investment earns interest not only on the principal component but also gives interest on interest. So compounding is basically interest on interest. When we say that the investment will be compounded daily, it means that we will earn interest on the daily interest along with the principal.

The concept is such that it assumes that the interest earned every day is reinvested at the same rate and will get increased as the time passes.

Animal Spirits

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Animal spirits refers the state of confidence or pessimism held by consumers, businesses and investors. Regarding financial markets, they represent the emotions of confidence, hope, fear, and pessimism that can affect an investor’s financial decision making, which in turn can fuel or hamper economic growth.

If spirits are low, then confidence levels will be low, which will drive down a promising market—even if the market or economy fundamentals are strong.

Likewise, if spirits are high, confidence among participants in the economy will be high, and market prices will soar.

According to the theory behind animal spirits, the decisions of investors and business leaders are based on intuition and the behavior of their competitors or other investors rather than on fundamental analysis.

Famous British economist, John Maynard Keynes believed that in times of economic upheaval, irrational thoughts might influence people as they pursue their financial self-interests. In 1936, Keyne published, The General Theory of Employment, Interest, and Money, where he postulated that trying to estimate the future yield of various stocks, companies, or financial activities using general knowledge and available insight “amounts to little and sometimes to nothing.”

Keynes referred to these psychological factors that make investors jump into the equity market — in the face of deep uncertainty and volatility, as animal spirits. He thought, only a manic, driven, strong-willed person would put capital at risk in periods of high uncertainty and volatility.

When animal spirits are strong, investment is sufficient to maintain aggregate demand; when they lag, aggregate demand falls, and the economy lapses into depression.

It is assumed that the only way people can make investment decisions in an uncertain and extremely volatile environment is if animal spirits guide them.

Source: CARLA TARDI, Animal Spirits, Investopedia, Updated Apr 20, 2019

Democracy and Economic Opportunity

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Frustration with polarizing politicians, unequal wealth distribution and personal economic opportunities breed dissatisfaction with democracy in America

“The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.”
– Winston Churchill

A Pew Research Center survey found that the discontent that many citizens of democratic countries feel are tied to concerns about the their respective domestic economies, individual rights and out-of-touch elites. Furthermore, most believe elections bring little change, that politicians are corrupt and out of touch and that courts do not treat people fairly. On the other hand, citizens are more positive about how well their countries protect free expression, provide economic opportunity and ensure public safety.

Several surveys of how well democracy is working for the average citizen vary considerably across nations. In Europe, for example, more than six-in-ten Swedes and Dutch are satisfied with the current state of democracy, while large majorities in Italy, Spain and Greece are dissatisfied, according to the Pew Research Center survey. Thus, it is safe to assume that citizens per capita income and their respective country’s economic business cycle seem to impact democratic dissatisfaction differently in some advanced and emerging economies.

Furthermore, it appears that there is a considerable correlation between the prevailing views of the domestic economy and the assessments of democratic performance. If the domestic economy is growing and the perceived distribution of wealth are seen as relatively equitable, then people tend to have a more favorable view of democracy.

Source: RICHARD WIKE, LAURA SILVER, AND, ALEXANDRA CASTILLO, “Many Across the Globe Are Dissatisfied With How Democracy Is Working”, APRIL 29, 2019

Importance of Embracing Failing

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Everyone, and we mean everyone, experiences failure in life.

The difference is that most successful people have embrace and learned invaluable lessons from failure. Essentially, when they fail; when they embrace failure, they tend to learn lessons from the experience. They tend to grow and mature. They achieve new understandings and perspectives on life, love, business, money, investments, relationships, and people.

You can’t control the volatility of the stock market, market forces, the miserable weather or readers dismal response to your blog post. What you can control is your reaction to it.

We must learn how to embrace failure positively and understand that fearing failure only holds us back from realizing our full potential. By recognizing and accepting that everyone fails, we are better able to embrace failure as a regular part of life. For example, American President Lincoln and British Prime Minister Churchill both failed multiple attempts to get elected to public office until becoming President of the United States and Prime Minister of Great Britain, respectively. Thus, since most of what we learn is from trial and error, beginning when we fall down again and again trying to walk, it’s only natural to recognize that everyone fails … and often.

“Winning is great, sure, but if you are really going to do something in life, the secret is learning how to lose. Nobody goes undefeated all the time. If you can pick up after a crushing defeat, and go on to win again, you are going to be a champion someday.” William Rudolph

Thomas Edison, one of the greatest inventors in modern history, once said, “Genius is one percent inspiration, ninety-nine percent perspiration.” While experimenting on the incandescent light bulb, Edison exclaimed to a reporter’s question, “I have not failed. I’ve just found 10,000 ways that won’t work.” Success typically comes after numerous failures. There’s something magical that happens when you don’t give up.

Failure can be an immense asset if we are trying to improve, grow, learn, or do something new. It’s the necessary feature that precedes nearly all successes. And, there’s nothing shameful about being wrong, about changing course. Each time it happens we have new options. Problems can become opportunities and new insights to solve old challenges. Deep down we know that our past failures have contributed immensely to our personal growth.

People fail in small ways all the time. To gain the benefits, we have to learned from the failure. The simple truth is – no great success was ever achieved without failure. It may be one seemily life changing failure. Or a series of failures. But, whether we like it or not, failure is a necessary stepping stone to reaching our ultimate goals and achieving our dreams.

Carried Interest Tax Loophole

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The carried interest loophole is just one of many ways the U.S. tax code offers preferential treatment to some Americans.

The U.S. tax code treats earned income from labor and investment income from dividends and capital gains differently.

If you are paid for performing a service (such as managing a company), your compensation is subject to ordinary income tax rates.

If you make an investment (such as buying the stock of a company), any profits you earn when selling that stock are subject to the lower capital gains tax rates.

Carried interest loophole allows people who manage investment funds, such as private equity funds and hedge funds managers, convert their compensation as if it were into lower-taxed capital gains, when it is actually derived from the labor and skill involved in managing other people’s investments.

Essentially, the partners in businesses that manage pools of money on behalf of investors are paid in two ways. One part of their income is a “management fee” for managing the investments. This fee is generally taxed as ordinary income.  The other part of the fund managers’ income is their cut of the fund’s profits. The fund managers treat their part of the fund’s earnings as a capital gain, subject only to the lower-taxed capital gains tax rate.

Balancing-Taxes-figs_webtable

Investment managers typically take a management fee equal to just 2 percent of the assets they manage—plus a 20 percent cut of their investors’ profits. In doing so, they are able to shield the bulk of their income from ordinary tax rates.  As a result, theses wealthy fund managers have experienced disproportionately large income and wealth growth compared to everyone else.

Source:  Seth Hanlon and Gadi Dechter, “Congress Should Close the Carried Interest Loophole”, (Washington:  Center for American Progress, posted December 18, 2012), available at  https://www.americanprogress.org/issues/economy/news/2012/12/18/48469/congress-should-close-the-carried-interest-loophole/

 

What Are Cyclical v. Defensive Stocks? – TheStreet

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Cyclical companies are those that see higher revenue growth when the economy is growing and lower revenue growth – sometimes contractions — when the economy is in recession.
 
Defensive companies keep humming along whether or not the economy is growing.

— Read on www.thestreet.com/video/-what-are-cyclical-v-defensive-stocks–15178611

7 Low-Risk Investments With High Returns in 2019 | TheStreet

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Low-risk is a relative term when it comes to investing. The classic risk-free investment is Treasury securities, but even they carry some degree of price risk. For those looking for low-risk investments, here are some to consider….

— Read on www.thestreet.com/personal-finance/low-risk-investments-with-high-returns-15170504

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Technology companies, such as Google, Facebook, Amazon, and TikTok, are not only social media companies. At their core, they are primarily massive data collection companies which collect massive amounts of individuals’ public and private personal information.

When individuals share vacation photos on Facebook or search for birthday gifts on Google or use TikTok’s mobile app to share activities with a colleague, this information is collected, manipulated and assessed for the monetary benefit of the social media company.

Privacy of individuals’ information, a major concern of citizens of Western Europe and the United States, and nonexistent for citizens of Communist China and the Russian Federation, are a growing concern.

Compound Interest

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“Wealth, like a tree, grows from a tiny seed. The first copper you save is the seed from which your tree of wealth shall grow. The sooner you plant that seed the sooner shall the tree grow. And the more faithfully you nourish and water that tree with consistent savings, the sooner may you bask in contentment beneath its shade.”
George S. Clason, Richest Man in Babylon

The real secret to compound interest is less about the amount that is saved, and more about the amount of time it is invested. One final advantage to begin saving and investing earlier rather than later is that the stock market presents a much better opportunity for long-term investors than it does for short-term investors.

Although nothing is ever guaranteed when it comes to investing, history shows that the longer you are invested, the greater your chance for favorable returns. What truly matters in investing is not timing the market but time in the market. Get money invested early so your time horizon is long enough to ride out short-term market volatility in pursuit of long-term gains and achieving long term goals.

Pay Yourself First and Automate Your Investments

It is recommended that you pay yourself first and that at least 10% to 15% of your income is saved into your retirement accounts.

Most Americans tend to save wants leftover after paying their monthly bills and spending on discretionary items. Instead, a better way is to spend what is left after first putting a percentage of income into savings. The easiest way to make this happen consistently is by setting up automatic contributions from each paycheck to a retirement savings account. But don’t stop there. It is also recommended that you increase your contributions each year or with each raise.

A small increase in your contributions won’t be very noticeable, but it will make a big difference in your balance over the long term.

  • The longer your money is invested, the more compounding you experience.
  • Stock market should be viewed as a long game, not a quick turnaround.

Because of these reasons, you should start saving and investing today.