What is compound interest? Small changes can impact your wealth.
Small differences often separate the average from the exceptional. Investing little and often from an early age may offer extraordinary results.
Across all areas of life, it’s often small differences that separate the average from the exceptional. Usain Bolt, the fastest person in history over 100m, completed the sprint in 9.58 seconds. The second fastest are Tyson Gay and Yohan Blake, who are both just 0.11 seconds slower and yet most people have never heard their names.
The same goes for 2019 Formula One champion, Lewis Hamilton who earns a reported $48m each year. His team mate, Valtteri Bottas, earns a reported $7.5m each year yet he came second in the championship.
Ok, so both these examples are slightly left field and don’t necessarily represent the real world that you and I live in.
However, they do make an excellent point.
Small differences can lead to exceptional results.
Let’s kick things off with something we can all relate to, Coffee.
Regular purchases really add up.
Imagine you are 20 and just starting out in your first job. You are getting a good salary, it is engaging work and a great company to work for.
Every day you stop by your favourite coffee shop on your way in and order a soy latte to-go for £2.80. That’s nothing in the grand scheme of things. However, it soon adds up. £2.80 five days a week is £14. Let’s say you work 48 weeks of the year, so £14 x 48 is £672 (that’s £56 each month, on average).
Now, most people will likely retire in their 60s. So, a career from age 20 to 65 is 45 years. As a result (and in very basic terms), you will have spent £672 each year, over 45 years resulting in a total latte spend of £30,240.
Yes, that’s a big number. But, over a lifetime, you might think that it’s a small price to pay for the interaction with your barista and the familiar hit of caffeine each morning.
As you might imagine though, there’s more to it than that…
Compound interest truly is magic and could make you wealthy with relatively little effort.
Back to the coffee analogy.
Rather than buy a coffee each morning, you decide to use the free coffee supplies at work. Yes, it’s likely to be instant – but needs must.
Instead, you decide to invest the £672 latte fund each year in a market-tracking index fund. How would that look?
The FTSE All Share index averaged 9.9% over the last 30 years – meaning that some years it performed better than this and others were worse. In our example we’ll use 8% to be on the conservative side.
Are you sitting down?
£56 invested monthly with an annual growth of 8% over a working life of 45 years could result in a total of over £297,000!
That’s an incredible start to a retirement fund alone, as long you have been intentional and invested the money with total regularity.
What’s the secret?
It’s compound interest. In basic terms (ignoring inflation), the interest earned on your investment generates its own interest, which in turn generates its own interest and can build into a massive, wealth building snowball.
Let’s break that down:
Investing the cost of a coffee each day.
As you can see, compound interest is not particularly interesting until at least a decade has passed. However, after this point the figures start to get big very quickly and before you know it, the snowball has such momentum that in just 5 years (years 40 to 45) the balance could grow by over £100,000.
Perhaps though, you don’t think the figures represent what you might imagine ‘wealthy’ looks like. Let’s up the ante a bit. Using the same variables, but increasing the regular investment from £56 each month to just £100 – you could be looking at a balance of over £530,000 by year 45. That’s an extra £233,000 for an additional £44 each month.
Inevitably, you’ll want to know how to become a millionaire? Again, with the same variables (8% growth over 45 years) a regular monthly investment of £190 could result in a final balance in excess of £1m.
That’s wealthy in anyone’s book.
How to become a millionaire with compound interest.
Summary
So, one way to potentially become wealthy is to commit to regular investing over an extended period of time. This could be achieved by cutting out that coffee, cancelling your satellite TV subscription, choosing a more fuel-efficient car or being more careful with your weekly shopping.
The most important thing though is that regular investing is an integral part of your monthly budget and not an afterthought at the end of the month when you are spent out.
Clearly though, the closer you are to retirement, the more money you may need to invest each month to achieve the results you want. Equally, with less time you are more likely to be exposed to the ups and down of market conditions.
Have a play with the figures yourself on this compound interest calculator to find out what you need.
To read more about personal finance and your money, you can find more blogs over on our newsfeed. Alternatively, if you have specific questions about regular investing or anything else to do with your money, please get in touch to speak to one of our Advisers. Don’t forget, this article offers information about financial planning and should not be taken as personal advice.
Are you investing each month? What are your top tips for raising the extra money needed? Share with us in the comments below.