At a glance

  • Putting the profits from savings or investments back into the pot can be the key to real long-term growth
  • Compounding means that even just by paying in little and often, investors can make their money go a long way
  • The younger the investor, the bigger the impact that compounding can have

At a glance

  • Putting the profits from savings or investments back into the pot can be the key to real long-term growth
  • Compounding means that even just by paying in little and often, investors can make their money go a long way
  • The younger the investor, the bigger the impact that compounding can have

At a glance

  • Putting the profits from savings or investments back into the pot can be the key to real long-term growth
  • Compounding means that even just by paying in little and often, investors can make their money go a long way
  • The younger the investor, the bigger the impact that compounding can have

Albert Einstein apparently considered it the “eighth wonder of the world”, and it’s one of the best tricks in the book for anyone wanting to grow their money.

Compounding is one of the simple fundamentals of investing that also happens to be hugely effective.

So what is it? And why is it so important?

The basics

Compounding is the snowballing effect that happens when the money generated by savings (in the form of interest) or investments (such as through dividend payments) is put back into a savings account or reinvested, going on to generate its own growth.

A simple way of looking at it is to start at the beginning. When you pay money into a building society, for example, you will hopefully be left at the end of year one with the money you paid in and the interest you made on it. You keep that money – original sum and profit – in the account, so that after two years you’re making a profit not only from the money you paid in, but also from the first-year profit you put back into the pot. The longer you keep doing that, the bigger the pot becomes, hence the analogy of a snowball rolling down a hill and gaining in size the further it goes.

You’re not doing any more work, paying additional money in or taking any extra risk. All you’re doing is reinvesting the income from your savings and letting compounding work its magic.

Keeping it regular

Compounding helps explain why regular investing can be such a valuable discipline, as even modest sums can build up significantly over time.

Drip feeding into an investment containing funds, for example, also gives you the benefit of pound-cost averaging. This means that by making regular (ie monthly) investments, you’re buying units of funds at different prices as markets rise and fall. In other words, you’re buying more of an investment when prices are low and so benefiting even more when they go up again.

Making time count

Generally, the longer you invest, the more powerful compounding becomes.

This provides a particular opportunity for younger investors with potentially decades of investing ahead of them, giving them a chance to grow their money into a sizable fund, even with modest regular payments.

For example, say you invest £10,000 into a Stocks & Shares Individual Savings Account (ISA) that gives you average growth of 6% a year. If you take the annual growth in cash each year, the ISA will still be worth £10,000 each year. Alternatively, you can keep that 6% gained in the fund each year. After 20 years of 6% average growth, your original £10,000 investment would more than double in value to £20,000.

Keep reinvesting that annual growth in the ISA over 40 years at average growth of 6%, and your £10,000 would be worth more than £92,000.

These figures are only examples and are not guaranteed – they are not minimum or maximum amounts. What you will get back depends on how your investment grows and on the tax treatment of the investment. You could get back more or less than this.

Patience is an investment virtue

Reaping the rewards of compounding requires staying power. While it can be tempting to sell out when prices are falling and get back in when they rise again, you’d need a crystal ball to get it right. What’s more, even just a few days out of the market can be very costly.

Let’s take the 2008 financial crisis as an example. Many cashed in their investments as markets fell, while those that stayed in had their patience rewarded. A £1,000 investment in early 2008 into a fund tracking the US S&P 500 Index would have lost almost 40% of its value after the first year. By the end of 2012, however, successive years of rising markets would have made it worth £79 more than the original £1,000. 1

That might not sound like much, but selling out when markets were down in late 2008 would have made that recovery much less likely and meant missing out on a period of stock market growth.

 

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

Albert Einstein apparently considered it the “eighth wonder of the world”, and it’s one of the best tricks in the book for anyone wanting to grow their money.

Compounding is one of the simple fundamentals of investing that also happens to be hugely effective.

So what is it? And why is it so important?

The basics

Compounding is the snowballing effect that happens when the money generated by savings (in the form of interest) or investments (such as through dividend payments) is put back into a savings account or reinvested, going on to generate its own growth.

A simple way of looking at it is to start at the beginning. When you pay money into a building society, for example, you will hopefully be left at the end of year one with the money you paid in and the interest you made on it. You keep that money – original sum and profit – in the account, so that after two years you’re making a profit not only from the money you paid in, but also from the first-year profit you put back into the pot. The longer you keep doing that, the bigger the pot becomes, hence the analogy of a snowball rolling down a hill and gaining in size the further it goes.

You’re not doing any more work, paying additional money in or taking any extra risk. All you’re doing is reinvesting the income from your savings and letting compounding work its magic.

Keeping it regular

Compounding helps explain why regular investing can be such a valuable discipline, as even modest sums can build up significantly over time.

Drip feeding into an investment containing funds, for example, also gives you the benefit of pound-cost averaging. This means that by making regular (ie monthly) investments, you’re buying units of funds at different prices as markets rise and fall. In other words, you’re buying more of an investment when prices are low and so benefiting even more when they go up again.

Making time count

Generally, the longer you invest, the more powerful compounding becomes.

This provides a particular opportunity for younger investors with potentially decades of investing ahead of them, giving them a chance to grow their money into a sizable fund, even with modest regular payments.

For example, say you invest £10,000 into a Stocks & Shares Individual Savings Account (ISA) that gives you average growth of 6% a year. If you take the annual growth in cash each year, the ISA will still be worth £10,000 each year. Alternatively, you can keep that 6% gained in the fund each year. After 20 years of 6% average growth, your original £10,000 investment would more than double in value to £20,000.

Keep reinvesting that annual growth in the ISA over 40 years at average growth of 6%, and your £10,000 would be worth more than £92,000.

These figures are only examples and are not guaranteed – they are not minimum or maximum amounts. What you will get back depends on how your investment grows and on the tax treatment of the investment. You could get back more or less than this.

Patience is an investment virtue

Reaping the rewards of compounding requires staying power. While it can be tempting to sell out when prices are falling and get back in when they rise again, you’d need a crystal ball to get it right. What’s more, even just a few days out of the market can be very costly.

Let’s take the 2008 financial crisis as an example. Many cashed in their investments as markets fell, while those that stayed in had their patience rewarded. A £1,000 investment in early 2008 into a fund tracking the US S&P 500 Index would have lost almost 40% of its value after the first year. By the end of 2012, however, successive years of rising markets would have made it worth £79 more than the original £1,000. 1

That might not sound like much, but selling out when markets were down in late 2008 would have made that recovery much less likely and meant missing out on a period of stock market growth.

 

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

Albert Einstein apparently considered it the “eighth wonder of the world”, and it’s one of the best tricks in the book for anyone wanting to grow their money.

Compounding is one of the simple fundamentals of investing that also happens to be hugely effective.

So what is it? And why is it so important?

The basics

Compounding is the snowballing effect that happens when the money generated by savings (in the form of interest) or investments (such as through dividend payments) is put back into a savings account or reinvested, going on to generate its own growth.

A simple way of looking at it is to start at the beginning. When you pay money into a building society, for example, you will hopefully be left at the end of year one with the money you paid in and the interest you made on it. You keep that money – original sum and profit – in the account, so that after two years you’re making a profit not only from the money you paid in, but also from the first-year profit you put back into the pot. The longer you keep doing that, the bigger the pot becomes, hence the analogy of a snowball rolling down a hill and gaining in size the further it goes.

You’re not doing any more work, paying additional money in or taking any extra risk. All you’re doing is reinvesting the income from your savings and letting compounding work its magic.

Keeping it regular

Compounding helps explain why regular investing can be such a valuable discipline, as even modest sums can build up significantly over time.

Drip feeding into an investment containing funds, for example, also gives you the benefit of pound-cost averaging. This means that by making regular (ie monthly) investments, you’re buying units of funds at different prices as markets rise and fall. In other words, you’re buying more of an investment when prices are low and so benefiting even more when they go up again.

Making time count

Generally, the longer you invest, the more powerful compounding becomes.

This provides a particular opportunity for younger investors with potentially decades of investing ahead of them, giving them a chance to grow their money into a sizable fund, even with modest regular payments.

For example, say you invest £10,000 into a Stocks & Shares Individual Savings Account (ISA) that gives you average growth of 6% a year. If you take the annual growth in cash each year, the ISA will still be worth £10,000 each year. Alternatively, you can keep that 6% gained in the fund each year. After 20 years of 6% average growth, your original £10,000 investment would more than double in value to £20,000.

Keep reinvesting that annual growth in the ISA over 40 years at average growth of 6%, and your £10,000 would be worth more than £92,000.

These figures are only examples and are not guaranteed – they are not minimum or maximum amounts. What you will get back depends on how your investment grows and on the tax treatment of the investment. You could get back more or less than this.

Patience is an investment virtue

Reaping the rewards of compounding requires staying power. While it can be tempting to sell out when prices are falling and get back in when they rise again, you’d need a crystal ball to get it right. What’s more, even just a few days out of the market can be very costly.

Let’s take the 2008 financial crisis as an example. Many cashed in their investments as markets fell, while those that stayed in had their patience rewarded. A £1,000 investment in early 2008 into a fund tracking the US S&P 500 Index would have lost almost 40% of its value after the first year. By the end of 2012, however, successive years of rising markets would have made it worth £79 more than the original £1,000. 1

That might not sound like much, but selling out when markets were down in late 2008 would have made that recovery much less likely and meant missing out on a period of stock market growth.

 

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

References

1. 20 Years of Stock Market Returns, by Calendar Year, The Balance, 2020

References

1. 20 Years of Stock Market Returns, by Calendar Year, The Balance, 2020

References

1. 20 Years of Stock Market Returns, by Calendar Year, The Balance, 2020

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