Albert Einstein stated, “Compound interest is the 8th wonder of the world. He who understands it, (the financially literate) earns it; he who doesn’t, pays it.”
Compounding normally refers to a bank account, and generally means you will collect interest on your money. Moreover, compounding also applies to other investments such as real estate and stock ownership. Example- On January 2, 2020, you purchased one share of Powers, Inc., at a price of $100. At the end of the year, the stock is trading for 20% more, so you now have one share valued at $120.00. Assume at the end of the second year the stock increases 30% in value. You gain 30% of the original $100 plus 30% of the increase of $20 from year one. Your one share is now worth $156.00. To summarize, compounding means your gains earned money as well as your original principle – hence the 8th wonder of the world!
Majority of Americans invest some savings in stocks because stocks can grow substantially more in value than say a bank CD. However, stocks carries risk so not only can they grow more than a bank CD but they can also lose all value. Think of 2020 bankruptcies such as Hertz, J.C. Penney; Nieman Marcus and many more.
THE WEALTH GAP
One reason for the wealth gap between African Americans and Whites is the ability (you need savings) and willingness to invest in stocks. Thirty-one percent (31%) of African American households, twenty-eight percent (28%) Hispanics and sixty-one percent (61%) of white households’ own stocks either through retirement accounts or directly as individuals. This large gap between households investing in stocks among African American and Whites, is a major reason for the wide and non-closing gap in wealth in the U.S.
IN ADDITION TO COMPOUNDING YOU CAN BE PAID TO OWN STOCKS
From 2004 to 2019, $13 Trillion or ~97% in shareholder payments, in the form of stock buybacks and dividends went to Whites. This is in comparison to $181 Billion (~1.4%) to black households and $212 Billion (~1.6%) to Hispanics. Look at the below table. Blacks are barely registering in this wealth transfer!
Dividends refers to cash, similar to an interest payment a company pays to its shareholders. EXAMPLE: Apple pays a ~0.97% dividend and Amazon does not pay a dividend.
Stock buybacks result when a company buys its own shares of stock back, reducing the number of shares on the market. Earnings per share (EPS) is a critical calculation that tends to move a stock price. If EPS increases a company’s stock price may increase. When a company buys back their shares, the EPS ratio increases because there are fewer shares.
WHAT YOU MISS BY NOT INVESTING IN EQUITIES
If you are saving money and not investing in equities, such as solely placing your funds in a bank, the highest percentage interest I found for a five-year CD is 1.5%. I calculated how much you would have at the end of three periods of time.
Assuming you saved $1,000 in a CD at 1.5 percent annual rate:
Number of Years
Value with Compounding
What if instead you invested that same $1,000 on one or two stocks, 23, 19 or 13 years ago. Take a look at what your $1,000 is worth today if you would have invested in a firm such as Apple or Amazon.
I am not recommending you run and buy either of the above stocks or any stock for that matter. I am strongly recommending you educate yourself how to invest in the stock market.
The easiest and lowest risk investment vehicle is what a well-known Billionaire, Warren Buffet, has set up for his wife when he dies. Her entire portfolio will be invested in an S&P 500 ETF. Read below to understand that investment.
As a child the only time I heard the word stock would be on television and seldom even there. I did not understand owning stock is owning a small portion of a company. In the African American communities, we typically do NOT have generational wealth, where grandparents, parents and family members openly discuss their stocks and other investments. In general, even today, there are few mentors to help us understand the importance of saving and investing. I am openly discussing stock and real estate investing and helping my daughter!
All of the topics I discuss with Amanda are posted on my blog!
In 2020, there are lots of conversations about racial inequality and how to achieve equality. In order to achieve equality, we must close other gaps.
The following five rules below are some simple steps to help close the wealth disparity:
- You earn income by becoming good in your field or trade. That requires education. Not just college education, but training in the trades. College is not for everyone!
- A mandatory rule- Spend less than you earn and SAVE THE REST. I read that a big named movie star is struggling to live on $7.5 million annually. Yep- I have no sympathy for that guy either!
- Improve your financial literacy. https://wealthbuildingpowers.com/2020/06/29/an-achievable-solution-to-the-racial-equality-gap/
- Invest in your company’s 401-K, your own IRA/ROTH IRA, your personal investment accounts.
- Grow your Net-Worth through the POWER OF COMPOUNDING.
THREE REASONS WEALTHY PEOPLE KNOW THEIR NET-WORTH
UNDERSTANDING COMPOUND INTEREST
COMPOUND INTEREST IS THE EASIEST WAY TO DOUBLE OR TRIPLE YOUR MONEY
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I am a proud nerd (as my beautiful wife and daughter have told me) investment and finance blogger, with a NC State, Chemical Engineering, University Rutgers, MBA and Harvard University, Advanced Management education.
I left a corporate career because I had a desire for making a difference as a speaker and writer, to help others. I was blessed to be coached and mentored by strong women and men in both my family and professional life. It is my time to serve and give back.
I started my first business at ~13 years of age (small but brilliantly created plant nursery). I am a successful investor in stocks, options, real estate and happy to share my personal finance and investment lessons learned with you.
However, I am NOT a licensed financial advisor. Please do not construe my suggestions on this blog, as recommendations for your personal situation. For individual finance advice please seek your own licensed CPA or fiduciary financial advisors.
I write this weekly blog to make an impact by reaching an audience and demonstrating the need for financial literacy. I will help you get there.