We always have other priorities when it comes to our finances and starting investments we know we SHOULD put in place.
However, your wealth is at significant risk from your inaction if you put off until tomorrow what you can do today.
This is due to the power of compounding over time.
Firstly, what is compounding?
When you invest, your initial investment is expected to grow in value due to the interest it earns, any dividend income it receives, and any capital gains it achieves.
Therefore, Compounding is the process in which these returns are reinvested to generate additional growth over time. When investment returns are reinvested each year it means that your investment doesn't just grow in a straight line, the new higher investment amount in the following year also has the chance of growing. Basically, your investment will generate earnings from both what you invested originally plus the accumulated earnings from preceding periods.
Compounding, therefore, means that when you invest, you benefit over time from reinvesting what you make to boost growth and elevate your wealth.
Let's bring this to life with a simple example.
Year 1: You invest £1,000. It makes a 10% return over the next year, meaning it grows by £100.
Year 2: You now have an investment of £1,100. If your investment grows by 10%, instead of earning £100 from your original £1,000, you make £110 from the higher amount of £1,100.
Year 3: You now have an investment of £1,210. If your investment grows by 10%, your investment will grow by £121.
And so on, this growth is exponential.
Understanding the impact of compounding your investment returns over time
The power of Compounding is HUGE over time. And it is this phenomenon that means inaction, or waiting to invest, can seriously cost you money over time.
Hargreaves Lansdown, one of the UK’s biggest self-investment platforms brings this to life incredibly well.
You start an investment today and you invest £150 a month. After 10 years you’ve personally invested £18,000, at which stage you stop paying more money in but leave your money invested for the next 30 years.
Your friend has other priorities and decides to wait 15 years before starting. They start with £150 a month. They invest for the next 25 years, investing £45,000 in total.
Forty years have now passed since you and your friend started investing. Your friend in this time has added two and a half times as much as you did for two and half times as long as you.
Assumption: Both of your investments grow by 5% a year on average. This, of course, is not guaranteed, but for this example, we’ll assume both you and your friend enjoyed these returns which are reinvested each year and annually compounded.
Who is better off? Let’s see!
After 40 years:
Your investment is worth £100,091, which costs you £18,000.
Your friend's investment is worth £87,877, which costs them £45,000.
By waiting 15 years your friend is £12,123 worse off than you despite saving £27,000 more for 15 years longer!
This is the power of COMPOUNDING and it is why you need to take action and start right now.
Whatever money you have available to you, if you invest it, it can have an atomic impact on your wealth.
If you don’t start, it will cost you in the long term.
Investments can go up and down, the examples here are for demonstrational purposes only, no investment advice is being given.
Not sure where to start? Get in touch! As a certified financial coach I am on a mission to help you feel confident to start investing.
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