The power of compounding returns

Investing Compound Interest

November 07, 2018 The power of compounding returns

This week, I want to talk you through compounding interest, often referred to as ‘compound earnings’.

Albert Einstein called it one of the ‘greatest mathematical discoveries of all time’. Many in the financial world refer to it as ‘a force of nature’ – a secret sauce, if you will. Whichever way you look at it, compounding returns have played a critical role in helping the rich get richer since the dawn of the financial world. Better still, it’s one of the simplest yet most effective strategies you can take advantage of as an investor.

It’s a big call, but I’d go as far to say that, as part of a wider investment strategy, it’s something that can seriously change the course of your life in terms of accumulating wealth and helping you realise your financial goals.

How it works

Ever heard of the old adage ‘get your money working for you’? Chances are whoever said it was referring to compounding returns.

Think of it like a snowball that accumulates more and more snow, gathering more and more momentum until it turns into an avalanche. Now, the earlier you start, the higher the ‘mountain’ and longer the ‘snowball’ will have to run down to accumulate more and more snow along the way.

In other words, you earn interest, then earn interest on that interest, then earn interest on that accumulated interest and so on and so forth over an extended period of time. Again, the earlier in life you can start, the more runway you’ll have. In saying that, though, it’s never too late to take advantage of compounding earnings.

Here, I’ll walk you through a couple of practical scenarios to help you get your head around it…

investment philosophy

Example 1

At the age of 19, Sam starts investing $300 into the sharemarket each month. After 10 years, he stops his contributions at age 29 and leaves his total investment of $36K to compound in the sharemarket until the ripe old age of 65. Max, on the other hand, starts investing at 30, investing precisely the same amount in the sharemarket each month until he’s 65. Over that 36-year period, his investment contributions total $130K.

At the age of 65, respectively, Sam ends up with $899,387 and Max with $673,568. Crazy, right?! Well, meet the magic of compound interest. Even though Max invested a significantly higher amount, the fact that Sam invested much earlier on gave him a higher and longer runway, hence why he ended up with more by the age of 65 after investing significantly less capital.

Example 2

Let’s say you pop $1,200 each year into a savings account earning an average of five percent per annum over the next 40 years (meaning, a capital outlay of $48K) and letting the law of compounding returns do its thing. In 40 years’ time, that $48K would have grown to more than $150K! In other words, you’d earn over $100K just by letting the interest compound over that time.

Still, have questions? Feel free to give me a shout to arrange a coffee, or drop me a line and I’ll flick you through our Investment Philosophy, which will give you both a broader understanding of our approach to investment advice and digs a little deeper into the first example I walked you through above.

Of course, if you are ready to take action today you can book in a chat directly with me below.

Disclaimer: all information contained within this article is of a general nature. It does not take into consideration your personal financial circumstances. Please consult a professional financial adviser (just like us 🙂 ) when making a financial decision.

 

Jason Chew
jason@orangewealth.com.au

I've been in the financial services industry for 10+ years and love coaching people to make the most of what they have.

2 Comments
  • Why fees can seriously cramp your investment style - Orange Wealth
    Posted at 10:31h, 13 November Reply

    […] of it as the exact opposite of compounding returns, namely compounding costs. Whereas the power of compounding returns can help send your portfolio […]

  • The cost of sending your kids to a Melbourne private school explained - Orange Wealth
    Posted at 16:14h, 21 March Reply

    […] Have a baby on the way? The time to start getting the jump on their education is to start squirrelling away is right now. I’ll give you an example as to how I’d approach it. Let’s start with an upfront investment of $5K and contribute $200 every month over the next 12 years. By compounding your return over that time, by the time they’re 12, you’ll have $48,452 to put towards their education. Now, that won’t pay for everything, but, hey, it’ll be a great start, particularly if you opt for a lesser-known, less expensive private school. You can read more about the magic of compounding interest right here. […]

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