Compounding: how to make ‘time’ work for you

By Raphaël Mennicken, Investment Director @ InvestEngine.

In this post, we’ll show why it makes sense to contribute regularly to your investment account (apart from the obvious benefit of having a regular savings budget and sticking to it, of course).

We’ll also introduce the concept of compounding (stay with us!) and show how it adds value to your portfolio.

The power of compounding

We can best demonstrate the power of compounding by looking at compound interest (in other words, the interest earned on interest already received).

Let’s assume the following:

  • You invest £500 every month for 20 years
  • The annual return offered by your account is 10%

This means that in total, you would have invested 12 x 20 x £500 = £120,000 over 20 years.

As the graph shows, the growth of your account over the 20 years can be broken down into 3 components:

  1. The value of the monthly deposits
  2. The value of interest earned
  3. The value of compounding.

As you can see, after 20 years, your account would be worth £361,993 based on a total investment of £120,000.

In fact, the value of compounding accounts for a larger share of your final account than either the £120,000 invested, or the total interest payable on your deposits!

How can this be?

Well, each £500 contribution contributes to the final total and, intuitively, it is easy to see that earlier contributions contribute more as the compounding effect has longer to play out. Let’s look at the contribution that contributes the most to the total: the first one.

Your initial £500 represents only a tiny percentage of the total amount invested 1/240=0.42%. However, that £500 has grown to £3,364 (6.7 times more), and represents 0.92% of your end account value.

More significantly, 55% of that £3,364 is made up by the value of compounding.

Regular investing and the magic of compounding have really made ‘time’ work for you!

The content of this blog does not constitute any kind of offer which may be accepted by you, nor does it constitute investment, legal or tax advice.   

Investengine (UK) Limited, does not provide advice and you are reminded that financial services are subject to various risks, you may therefore wish to consult a professional adviser for guidance.  It remains your responsibility to ensure that any products or services provided by us, continue to meet your specific requirements.

Investengine (UK) Limited assumes no liability for the completeness, timeliness and/or correctness of the content of this blog

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