At the same time as the pandemic is raging, recent statistics tell of record-high private savings in mutual funds and individual shares in Norway, writes Ronni Møller Pettersen.
By Ronni Møller Pettersen, Executive Vice President, Sparebank 1 Nord-Norge
This entry was first posted in Northern Norwegian Debate.
The economic scenarios resulting from the corona crisis are dramatic. Recent events in the world, and in Tromsø, suggest that the worst is not over yet. Simply because no one knows how viruses, vaccine development, infection control measures, consumption habits, the labor market and the extent of economic stimuli will proceed in the future.
At the same time as the pandemic is raging, recent statistics tell of record-high private savings in mutual funds and individual shares in Norway.
Strongly simplified, the increased savings are explained in two ways; i) it has simply become more difficult to spend money as a result of the measures to keep infection down, and ii) more persistent use of money as a result of increased uncertainty related to finances, jobs and the future.
The increasing savings trend is in any case very gratifying, and seems to have gained a firm foothold among the Norwegian people. Up in the misery, we thus see the start of a development that can prove to be very well timed. In the years to come, we will notice a Norwegian economy on oil weaning, increased costs associated with an aging population and a pressured welfare state.
Those who manage to keep their savings going in both economic ups and downs will be far better equipped to withstand the changes. Continuity in saving has a great effect. Because you’ve heard of 72 lines? Or if compound interest? If not, get a cold drink and sit back – these are both fascinating and powerful things:
72 lines is simply a rule of thumb that helps you figure out how long it takes to double a savings amount, given a fixed annual interest rate, and without new deposits. If you take the number 72 and divide by the expected return – then you are left with the number of years required to achieve a doubling of the savings amount. An expected annual return of 10 per cent (fairly high – but used to simplify) thus doubles the savings amount after 7.2 years (72 divided by 10). The rule is quite precise, very simple, and actually quite ingenious! Here are some more duplicate examples:
- One percent return: 72 divided by 1 = 72 years
- Two percent return: 72 divided by 2 = 36 years
- Six percent return: 72 divided by 6 = 12 years
- Eight percent return: 72 divided by 8 = 9 years
The difference in time by going from 1 percent to 2 percent return, is thus a full 36 years. Fascinating, right?
The 72 rule is otherwise very applicable and can be used for so many things. For example, the half-life of capital as a result of inflation, or the doubling of debt where neither installments nor interest are serviced. For example, if you have 100,000 in cash lying in the mattress with inflation on a par with the government’s inflation target (close to 2 per cent), then the value of your money is halved in the course of 36 years (72 divided by 2 = 36). Unpaid credit card or consumer debt will similarly double over a 3-year period if the annual interest rate is 24 per cent (72 divided by 24).
As the example shows, it will be possible to double several times during life, if you start early. How many doubles can you handle?
The above example is presented for the sake of simplicity without taking into account taxes and inflation.
The effect of the compound interest rate is powerful. In short, it is based on the fact that when you leave both the deposit and the return on it untouched over the year, you will also achieve a return on the return. It has a huge effect!
In the example below, Lars starts saving NOK 20,000 equity fund a year as a 19-year-old, and continues until he is 27. Then he stops saving, but he leaves the money in until he is 65 years old. Hermine only starts saving 20,000 kroner a year in equity funds only when she turns 27 – and she saves the same amount until she turns 65. This is how the final sums end up when Lars and Hermine are 65 years old:
Example Lars: Starts early and lasts for a short time – 8 years
- Lars saves 20,000 kroner a year for 8 years from the age of 19 until the year he turns 27
- Lars then leaves the money for 39 years until he is 65 years old without shooting any more.
- Annual interest rate is 10 percent
- Balance at age 65: NOK 10,351,615 (before tax and inflation), which consists of:
- Deposit amount: NOK 160,000
- Return: NOK 10,191,615 (!)
- Balance at age 65 in today’s money value (2 per cent annual inflation): NOK 4,781,872
Example Hermine: Starts a little later and lasts longer – 39 years
- Hermine saves 20,000 kroner a year for 39 years from the age of 27 until she is 65 years old
- Annual interest rate is 10 percent
- Balance at age 65: NOK 8,831,851 before tax and inflation, which consists of:
- Amount deposited: NOK 780,000
- Return: NOK 8,051,851
- Balance at age 65 in today’s money value (2 per cent annual inflation): NOK 4,079,858
- (figures presented before tax on return)
Lars only saves for 8 years, while Hermine saves for a full 39 years. Still, Lars will end up with more money than Hermine at the age of 65. One can only imagine the snowball effect for Lars if he also had the savings after the age of 27!
Albert Einstein allegedly called the interest rate effect the world’s eighth wonder, and the strongest force in the universe. Fortunately, you do not have to be a Nobel laureate in mathematics to understand, and not least take advantage of the interest rate. It keeps you from starting early and lasts for a long time.
The conclusion is simple: Start stock saving early and hold on for a long time. Both the early-part and the long-term part have a huge effect on returns. Do not do anything – neither when the market goes up or down (read: corona or other crises). Time means the most when talking about the stock market.
In the article, a 10 percent return has been used to simplify the calculations. This is a very high rate of return – which one cannot normally expect to achieve over time. The calculations may contain errors. The content of the article is not intended as any kind of recommendation or investment advice.