We all know that compounding is a glorious thing, but when does it start to matter? Let’s look at Barry the Zombie, who is saving £100 a month and invests this all at the end of each year. Go on Barry!
– A 50/50 allocation to bonds and equities.
– Gives us an expected portfolio return of 3% (we’ll assume savings are invested at the start of each year)
– A time horizon of 30 years
What’s not immediately obvious from this is how much of the growth is from our own hard earned cash being flung into the financial wastelands or how much is from the wonders of growth.
Comparing the growth from the contributions and the interest directly it looks something like this;
Blimey, that is exciting and a stunning graph.
So in the early formative years of this simple example our own contributions are providing most of the growth. Our income from growth takes over our contributions somewhere around year 23 or 24.
We would hope that our wages would grow and we would save more each year and not blow the raise on olives and houmous.
So we can assume that our contributions to savings simply increase in line with the increase in wages. Lets go crazy and Barry’s wages increase 1.5% above inflation, every year. We can live in hope. Our projections would now look like;
We see a little bit of that sweet compounding interest effect on our without interest line, i.e. the growth on our income is also compounding. Ayoooo!
Also, there is an increase in the total value at the end of thirty years of £12,405. Not bad really given all we have done is increase the amount saved by a paltry 1.5% year on year. Sounds small, but it does have a big impact and shows even small increases have a big effect.
If we compare the contributions paid and the interest earned each year, we see that the contributions paid are now larger than the interest earned for the first 27 years.
Just to drive the point home. We can have a look at the percentage growth in the fund value from our contributions or just from investment growth.
It’s pretty obvious from this that the contributions we are putting in far outweigh the growth in the early years.
So get with the plan, Stan
A few things are clear from this;
– Compounding has a substantial effect, even for what seem like small percentages
– The amount you save regularly has a huge impact on the financial nugget we accumulate (pretty obvious, right)
– In the first few years keeping that momentum going is all important
– Graphs are cool
Really, we can see from the above that early on simply saving regularly and keeping the ‘savings momentum’ going are going to have a bigger impact on your financial nugget than spending time finding that extra 0.25% growth.
As our financial nugget grows and grows then the amount of growth we are generating becomes more and more significant to us and we can start looking to trim the fat around the edges. But until then lets keep that momentum going.
Of course returns after inflation would be much more volatile than this, we might have to take money out from time to time, our wage growth isn’t likely to be as uniform as this (hopefully we would get more from a promotion than a normal year), we might have time off work, etc
And thanks to Barry.