Learn About Investing
It’s often said that investing is best done over the long term. One reason for this is a quirk of maths called ‘compounding’ or ‘compound interest’.
The good news - you can enjoy all its benefits without knowing how to calculate it.
There is a tale that Albert Einstein described compounding as “the most powerful force in the universe”.
He probably never actually said it, but compounding is nevertheless a powerful force when it comes to investing.
What is compounding and why does it matter?
If you invest you hope to see your money grow. If you reinvest the returns, in time these profits will themselves generate their own returns.
Or put another way, if you stick cash into a savings account it earns interest. If you don’t touch the account, there comes a point when you start to earn interest on the interest.
Over short periods these ‘returns on returns’ may not amount to a lot. But over time it starts to make a big difference.
An example of compounding
Imagine you make a one-off investment of £100 and leave it for 20 years. Let’s assume that each year your investments grow 6%.
If you took your £6 ‘profit’ out each year you end up enjoying 20 years of £6 returns.
So you get your initial £100 back plus £120 on top.
But if you leave those returns alone and come back after 20 years, the returns themselves have had a chance to build up returns of their own.
In this case you get your initial £100 plus £221.
So, by leaving the investment alone - and reinvesting - your returns nearly double (£120 vs. £221).
The difference just gets bigger the longer you leave it (assuming you maintain annual returns). It’s one the reasons why investing over the long term can make a great deal of sense.
Compound interest on £100
Assumption: 6% annual interest (growth) rate
Enter your own numbers to see how your money will grow