One of the main long-term benefits of investing is the impact of compounding.
Albert Einstein once described compounding as the eighth wonder of the world. But what
does it mean and why’s it so powerful? Well, effectively, compounding is when you
earn returns on your returns. So the longer you invest, the more you can potentially benefit.
Say you invest £10,000 and after the first year it’s gone up in value by 5% and is now
worth £10,500. If it grows by another 5% in the second year, that’ll be 5% of £10,500, not just
the original £10,000, so by the end of year two your investment would be worth £11,025, and so on.
Over time, compounding can have a significant impact on overall investment returns.
It’s a bit like a snowball rolling down a hill. It starts small but then gets bigger and bigger.
You benefit from the effect of compounding with cash savings too because of the interest
you earn. However the effect tends to be greater with investments because you
not only reap the reward if share prices go up and the value of your investments rise,
but you can also reinvest any dividends you receive which helps turbo charge things further.
Here’s an example in pounds and pence. If you invest £5,000 each
year from the age of 18 and assume it grows by 5% a year, it would be
worth over £700,000 by the time you reach 60. But if you wait until you’re 30 to start you’d
only have about £350,000 by the time you hit 60. This is why investing is so-well suited to
long-term financial goals. The idea is to get invested, and stay invested. It’s all about
time in the market, not timing the market. So the sooner you start the better, because
you’re giving your money more time to grow and longer to benefit from the magic of compounding.