Is compound interest the eighth wonder of the world?
[Estimated time to read: 4 minutes]
When I was at university, a BBC interviewer asked me whether students think about pensions.
“Pensions?” I laughed… “Students have more pressing things to think about than retiring!”
…tuition fees, student loans, studying, future job prospects…
These all ranked higher than a pension I wouldn’t need for decades.
And as for retirement, it seemed a long way off at 19!
A lesson I’d teach my younger self
If I could go back in time and tell myself anything, I would use the words of Tony Robbins, from his great book Unshakeable: Your Guide to Financial Freedom:
“You’re never going to earn your way to financial freedom.
The real route to riches is to set aside a portion of your money and invest it, so that it compounds over many years.
That’s how you will become wealthy while you sleep.
That’s how you will make money your slave instead of being a slave to money.”
The impact of impatience
Some people try to shortcut this process…
They don’t invest – they speculate!
In effect, they gamble their money in emotionally-driven investments – like houses, active funds, shares, and products sold to them by banks and brokers.
Other people just procrastinate.
People in both these camps have one thing in common.
They hope things will work out for them.
Hoping is why 95% of people live below their preferred standard in retirement.
All is not lost!
The truth is, it doesn’t matter how old or young you are…
Used right, the power of compounding can still be your route to greater prosperity - whether you’re 19, 39 or even 59.
But the American economist Burton Malkiel said:
“the majority of investors fail to take full advantage of the incredible power of compounding – the multiplying power of growth times growth.”
Because most people don’t know how amazing compounding truly is.
So, allow me to illustrate with an example…
A tale of two investors
Let’s take two 19-year-old friends – Stuart and Sam – each decides to invest £500 a month…
Stuart is a resourceful chap and starts investing at 19.
However, he only saves for eight years, then stops.
He manages to put £48,000 in his account then he leaves it alone.
His money starts compounding.
After eight years, his investment is worth £72,277.88 - assuming it compounds at 10% a year, which is the historic rate of the US stock market over the last century.
Stuart’s account then lies dormant, not being added to until he is 65…a period of 39 years.
The compounding continues…
Sam is slower off the mark…he doesn’t get started investing his £500 a month until he’s 27.
Remember, Sam’s the one who, at 19 laughed about pensions!
But, unlike Stuart, he’s consistent and disciplined. He invests every single month until he’s 65.
He manages to invest £234,000 in those 39 years – and of course, every penny compounds at our example rate of 10% a year.
At 65, whose account is worth more?
- Stuart’s, who started at 19 but only saved for eight years?
- Or Sam’s, who started at 27, and saved for 39 years?
When Stuart and Sam meet up for a reunion at 65, Stuart has £2,973,857.31 in his account – Sam has £2,537,257.67.
Despite investing for 31 years longer than Stuart, because Sam lost out on those first 8 years of growth, he’s the loser with £436,599 less in his account.
By starting earlier, the compound interest Stuart earns on his investment adds more value to his account than he probably could have added on his own!
But what if Stuart hadn’t stopped investing at 27, and had carried on adding £500 a month until he was 65 too?
He’d walk away with £5,511,115.02 at 65.
Compounding was Stuart’s route to greater prosperity…and it can be yours
Some people may believe that they have left it too late.
But the truth is that you’ll never be younger than you are today – so today is the best day to start.
For every day you wait, the power of the compounding effect is eroded.
If you want our help, because we know taking control of finances alone can be daunting, please just ask…
As one of his non-adviser colleagues said this week, after she’d asked Chartered Financial Planner Stuart Ritchie for financial advice:
“I’ve taken myself in hand and sorted out the money matters that I’d left hanging forever and a day…and my family and I will now be in a better position thanks to YOU…thank you!”
Albert Einstein allegedly said compound interest was the most powerful force in the universe.
Whether he really said it or not, that line has become my financial motto. I strongly suggest you adopt it too.