Don’t compound your problems: The Power of Compound Returns

There appears to be a misconception amongst many people that investments are an exclusive tool for the wealthy to make themselves even wealthier. This is particularly prevalent amongst younger professionals and is probably due to the nature in which investments are typically discussed. When they have heard about investments, it’s usually in the context of someone wealthy investing a large lump sum directly into shares in a company and regaling them with tales of the huge gains or losses made over a short time frame.

However, investing doesn’t have to be as harsh or as sudden as this. Rather than having to build up a large lump sum before investing, why not set up a regular payment that is affordable for your current circumstances? With most modern investment accounts it is now possible to adjust, pause or cancel your regular contributions at the click of a button, meaning as your income circumstances change you can amend your payments accordingly. Consistently putting away a small amount each month over the long term will give the funds plenty of time to grow and recoup any short term falls in value that may occur along the way.

I believe that one of the most underestimated elements of investing this way is the power of compound returns over the long term. This is the simple concept of having any growth achieved added to your original investment value, which will subsequently benefit from any further growth in future years. The longer you have to invest, the greater the cumulative effect of this compounding is.

To highlight this let’s look at an example:

Sarah, aged 25, has an ambition to own a luxury two seater sports car by the time she is 55. She currently has £50 per month that she could afford to put towards this goal. If Sarah were to start investing her money today and continue paying into the plan at the same rate up until age 55, then a 4% per annum growth rate would result in the plan being worth £34,702. Probably just enough for a nice run around!

 The other scenario, and one that we tend to come across quite often, is that Sarah doesn’t start to invest today. She instead plans to start investing later in her life when hopefully she will be earning more and can pay a larger lump sum into the plan. Years go by, during which the cost of Sarah’s lifestyle has increased roughly in line with her earnings, she has bought a house, had children, been on family holidays and helped her children through university. At age 50, she remembers about her old ambition of the luxury two seater and finally feels that she has the spare income to start saving.

If Sarah started investing at age 50, with a five year time horizon and assuming that a 4% per annum growth rate was achieved, she would need to invest approximately £524 per month, more than ten times what she would have had to save each month at age 25.

The lesson to be learnt from this example is that if you do delay your investment decisions, you will miss out on the power of compounding and will therefore be placing an additional burden on your finances later down the line as you are forced to play catch up for those lost years of saving.

There are plenty of options for those out there who are looking for the right way to invest and save money such as a pension or ISA. What is most important for those thinking about investing, is to seek advice to make sure you are embarking on the right path for your situation and objectives.

Our team at Cameron Chase will help you to assess your current financial situation, taking all factors into consideration, and provide recommendations on the most effective way for you to invest or save.

 

 

 

 

 

 

 

 

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