Compound Interest Without Selling of Stock

I just received an email from Will regarding CITISEC EIP, here you go:

"Gusto ko po sanang kunin ang advise nyo tungkol sa CITISEC EIP. Sabi po duon na maganda daw po ang PESO COST SAVING investment na long term. Naintindihan ko na po yuon pero sabi din nila na dahil long term e gagana ang "compounding" duon. Hindi ko pa maintindihan kung paano po sya mag compound kung hindi mo naman ibebenta. Oo nadadagdagan ang pera mo kasi bumibili ka monthly at lets say nag appreciate ang stock mo pero paano po mag compound kung hindi mo naman ibebenta dahil nga long term? Pwede nyo po ba ako paliwanagan bago ako mag start ng account."

As a start, I would like to impart that I am fascinated in compounding interest. I have always wanted to find a way years ago on how to increase my funds by reinvesting the interest on my money. Obviously, simple interest won’t work because it doesn’t include my earned profits every year in the computation of interest. Compounding interest suits my financial objective of increasing my money’s value every year. Allegedly, Albert Einstein said the compounding interest is man’s greatest invention. How come such a great scientist will utter those words? Maybe because compounding interest increases your money exponentially taking into account your principal as well as the profits in the computation of the interest.

Compounding interest is computed by adding the profits of the principal to arrive at the succeeding interest.

Please take a look at the screenshot I got from the EIP pages of COL and see the difference between the simple interest and compound interest. In simple interest, your profit every year is always 7,000 pesos, it never increased. However in compounding interest, your profit every year is always increasing. The reason of increased profit every year is that the interests you earned every year are being added (reinvested) in the computation of the succeeding interest. As time passes by every year, your profits increases.

Regarding your question on how compounding works without selling a stock every year, please take a look below on the computation I did in compounding interest.

For example, we bought 1 share of Globe worth 1,000 pesos today. Every year the stock is growing at a 7% rate.

In Dec 31, 2012, your profit is 70 pesos (1,000x7%).

In Dec 31, 2013, Globe shares increased by 7% again, your 2013 profit is now 1,144.90 (1,070x7%). We used 1,070 pesos in the computation because that is the price of Globe as of Dec 31, 2012. Remember, the compounding interest used by COL in the above screenshot is annual. Also there is no selling transaction here yet.

In Dec 31, 2014, Globe shares increased by 7% again. Your 2014 profit is now 1,225.40 (1,144.90x7%). We used 1,225.40 because that is the price of Globe as of Dec 31, 2013. Whatever is the last price every Dec 31, that will be the basis of the interest computation. Again, no selling of sock is involved here. 

Interest   Globe Price   Today                        -                     1,000.00 31-Dec-12                70.00                   1,070.00 31-Dec-13                74.90                   1,144.90 31-Dec-14                80.14                   1,225.04

Time is Money!

When I started working for a job, I am afraid to plunge in the world of stock market. I do not know how the stock market works. Even though I am an accountant by profession, investing in the stock market during my early twenties did not cross my mind.

I remember when I used to read Manila Bulletin or Philippine Daily Inquirer, I will normally browse the sports section first. As I flipped through the pages and turn to the business section, I cringed. You know why? Because I do not understand what Phisix is all about. I do not understand what these tickers are all about. Most of all, I do not even know what are the implications of these information in my daily life. Do they really matter to me? The answer is no during those days. Perhaps during my college years, I was absent when those topics were discussed or maybe I just had a very short memory that does not last a month.

Stock market? Nah, let’s talk about savings instead. When I wore my first long sleeves and khaki pants towards my first job, I thought of savings a part of my salary. What I did on the ensuing months was to withdraw enough money to sustain me for the next 15 days and the rest will be left in my ATM. I then leave my ATM in our apartment. The reason why I am leaving my ATM in our apartment is to resist the temptation of overspending.

50% discount sales abound everywhere. From the malls, supermarkets and grocery chains, the endless promotions are there. The cool polo shirts are a catch, the Levi’s pants were cheap and the Nike shoes were all latest model. These and all sort of things that tempts me in pulling my wallet out of the blue is being nullified because I do not bring my ATM. While I do resist myself in buying unnecessary items, I sometimes indulge myself in the things I wanted like watching movies and PBA basketball, going for a few drinks in a bar, and buying books I wanted to read. These are the things that I get from my ATM from time to time for my own well-being.

Just like everyone else, I know that time deposit will be better than leaving my money in the bank or in my ATM. Interest rates are higher when you have a time deposit than a savings account. The longer the time period of the deposit, the higher the interest rates are. Normal interest rates for deposits are 3 to 5 percent. Not bad if you compare it against the savings interest of 1% or less.

The drawback of these time deposits is that it cannot cope up with the inflation. If you have 1,000 pesos today to buy 25 liters of gasoline, maybe next year you will need 1,050 to buy 25 liters of gasoline. Then next next year, you will need 1,100 to buy the same 25 liters of gasoline. The product stays the same but the value of your money is decreasing every year because of inflation. Time deposit cannot totally offset the loss of the value of your money every year.

So, how can we beat inflation then and preserve the value of our money? Well, you can try bonds, mutual funds and stock market as a beginner investor. Theoretically, bonds and mutual funds are safe for beginner investors. However, I never touched those two investment vehicle when I started investing. I went straight to the dreaded stock market. I do peso cost averaging in my early years in investing. I just buy blue chip companies every month and let them grow. That’s it. The average return of the stock market is 14% every year. Thus, even if the inflation grows to 5%, you can still preserve the value of your money because your return every year is 14% which is higher than the inflation.

Obviously investing in the stock market is out of our comfort zone. This is totally new to us. So many questions surround us in every opportunity that appears in front us and most of the time, those questions are left unanswered. Thus, we just ignore the opportunities that we have in our life. What I believe is that we need to be curious in this opportunity, research about it, ask questions to the professionals, buy a book, take a seminar and of course grab it and do not let it pass. An opportunity that passed already will never appear again. You’ll need to wait for another opportunity to come and you will never know if that another opportunity will come. In essence, time is money.