Lately I have been getting some questions from young people who are just starting out their investment career and also from parents. Parents are wondering how to set their children up for financial stability given that it seems unlikely that you should put all your trust in the public pension systems to take care of you.
I must say that I really enjoy answering these types of questions and I learn a lot from interacting with young people about finances and investing.
Compounding of interest
I usually start by showing a chart that illustrates the power of compounding interest. If you start saving 1,000 SEK (100 USD) or 2,000 SEK (200 USD) each month from when your child was born and you get an average of 10% return each year, how much money would that end up being?
The chart below shows this calculation for 1,000 SEK per month with the bottom axis showing number of years.
If you instead invest 2,000 SEK per month the results are as follows.
This is nothing short of amazing, with only 1,000 SEK per month invested, at the time the person turns 40, the person will have more than 5 million SEK in their account. If you muster to invest 2,000 SEK per month the person will reach 5 million SEK at the age of 33 and at age 40 the amount will be over 10 million SEK.
This of course assumes that all returns are re-invested into the portfolio and not used for any living expenses. Now let’s look at the annual returns.
Annual returns
With 1,000 SEK down per month the annual returns would be according to the chart below.
At age 40 that would mean over 500,000 SEK per year. If the investment would be 2,000 SEK instead the return would look as follows.
This would mean over 1 million SEK per year in returns at age 40. At age 65 with 2,000 SEK invested per month the annual return would be almost 12 million SEK per year and total capital of around 120 million SEK!
How to get returns?
Now on to the hard part, getting 10% return every year over a period of 65 years is hard, but not impossible. Some years you will get a higher return and some years you will end up with a loss depending on what you have invested in. You will also have years when your portfolio of investments overperforms the general market and some years when it underperforms.
Here is an example of one of my own portfolios that I started just in February this year.
It is up 33% since then and including the dividends that I have received it is up almost 40% this year. This is a very conservative strategy that is designed to invest in dividend generating stocks which are undervalued. During this period the Swedish market index called OMXS30 is only up 7.19% so currently this strategy is widely overperforming. Over time though it is designed to generate around 8 – 10% per year.
From when I was 22 years old, in the year 2000, until 2006 I was a money manager. I had a hedge fund based in Chicago and I was investing and trading other peoples money including my own. This was a great experience but I also realized that I liked building companies and managing my own investments more than managing other peoples money.
The bucket system
I developed a philosophy that I call “The Bucket System” and that is what I now teach to people that are interested. More on the bucket system in my next article so stay tuned!