In our previous article we introduced the concept of Compound Interest (CI) see Part 1. We spent a great deal discussing the importance of compounding periods. I hope you have gotten a chance to ponder and reflect. In this article, we will explore the importance of periodic investment top-ups. We will explore the following scenarios:
- Lump sum initial investment with no top up
- Zero initial investment with monthly top up
- Lump sum initial investment with monthly top up
For each of these scenarios, we will assume we are getting the same annual interest rate which is compounded monthly. Our main interest is to track the performance of each scenario over 10 years and the value of the investment at month 120 (year 10).
Compound interest is a tail heavy process. You really start seeing the results only after a certain period of time.
Scenario A: Lump sum initial with no top up
Suppose Rotich has gotten a huge bonus in the last fiscal year of 100K and decides he wants to invest it say in a money market that will give him a 10% annual return compounded monthly. At the end of 10 years (month 120), the fund will be worth approx. Ksh. 270,704 which means his original investment will have nearly tripled in that span.
Scenario B: Lump sum initial with monthly top up
Suppose Rotich had decided to invest the same 100K but also top up his investment with monthly contributions of 10K. At the end of the 10 years, his fund would be worth approx Ksh. 2,319,153. This is nearly 10X of the amount in scenario A
Scenario C: Zero initial with monthly top up
Suppose Rotich didn’t get a bonus so he is starting his investment journey with zero principal. His plan is to start the monthly contribution of Ksh. 10,000 at the end of the month 1. 10 years of continuous top-ups his investment fund would be worth approx Ksh. 2,048,449.79. I know you are probably scratching your head and wondering what the heck just happened.
So what really happened?
Compound interest favours the patient investor and is very responsive to new principal infusions. Every time you are topping up your fund you are adding to the principal which then means that the amount of interest goes up and in turn the interest on interest keeps growing. This is where you unleash the beast in compound interest.
Notice in the last 2 scenarios that at the end of years 6 and 7 respectively, the interest you are earning is nearly equal to the contribution you are making. This would mean that if you stopped making further contributions that fund should keep growing by 10k every month to perpetuity.
For scenario A to achieve the same value as the other 2 scenarios, Rotich would need to invest approx. Ksh. 850,000 at the beginning. This is a high capital requirement whereas a simple monthly plan of 10K/month still gets the same return.
The last column in the table tracks how the interest amounts at the end of every year compared to the interest earned in the first year. The sweet spot is when the factor reaches x10. That means you are getting interest equivalent to your top-up amount.
Key takeaways
- You don’t need a huge upfront investment to really grow your wealth
- Consistently topping up the investment pays off. This really benefits presents itself when you do it monthly
- In scenario A the fund still grew by a factor of 2.7 with Rotich not even topping up.
- Compound interest unleashes its beast mode when you give it time and infusions of new principal regularly
10 years is not a long time my dear friend, so start now and you can look back at this moment with a smile. Take a moment and reflect on where you were 10 years ago and if you could have started making the monthly contributions above you would be swimming in 2M. Word of caution: this can be an addictive behaviour especially when you start tracking the interest you are earning per month. You will be calling up those friends with madeni zako to boost your contributions.
Feel free to give your feedback/questions/suggested topics we should discuss in the comments section below and share the article with your friends that could benefit from it.
Next week we will explore some questions that arose from the article about Sacco dividends and explore more about Saccos.
NOTE:
A friend of mine asked me to share a list of some of the available local investment options and what type of interest they give. The table below lists some of the ones I have engaged with. If you have any to add on please leave it in the comments below.
