Don’t underestimate the power of compound returns

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By The Personal Investing Team

22 Jul 2018

Albert Einstein reputedly called compounding the “eighth wonder of the world”.  We agree. Here’s why it matters for you.

Whether you’re thinking of saving for a house, retirement or just a rainy day, you’ve probably been told that the sooner you start, the better. And it’s true. All else equal, the more time you give yourself to save, the better the chance you’ll have of achieving your goals.

But the reason behind this is not just that you’ll have more paychecks coming in from which to save. It’s also because you’ll give your savings more time to grow.

For instance, if you invest £100 and receive an annual return of 5%, you’ll have £105 waiting for you at the end of the first year. Nothing to sneeze at, but hardly life-changing. However, it’s when you leave your money invested for longer that things can really start to get interesting…

That’s because it’s not just your initial investment that has the potential to generate returns. The potential return on your returns can help you realise your savings aspirations more quickly.

Using the same example, the £105 you have at the end of year one would not grow to £110 after year two as you might think, but £110.25, with the £5 gain from year one generating £0.25 in its own right.

Projecting this further out into the future, and assuming constant annual returns of 5%, the same initial investment of £100 would grow to almost £128 after five years, £163 after 10 years and an exciting £339 after 25 years. Please note that this example is purely illustrative and real world returns may vary significantly from year to year.

Put simply, the potential returns on your returns really matter, and its power only grows over time. So while the best time to get started with your savings may have been a very long time ago, the second best time is today.

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Risk warning

Please remember the value of your investment and any income from it may fall as well as rise and is not guaranteed. You may get back less than you invest . Tax rules for ISAs may change in the future and their tax advantages depend on your individual circumstances.

Please note the information, data and any references in this article were accurate at the time of writing. Please check the date of the content if you’re looking for up to date investment commentary or tax-year related information.