The Power of Compounding

If you can work for your money, why not let your money work for you?

In fact, while working is a great way to make money, it’s not the only way. For most of human history, the only way to make money was to trade your time for it. It didn’t matter if you were a doctor or a miner: if you wanted to earn money, you had to work for it.

But imagine that there was an alternative. Instead of working a shift for a fixed wage, you could invest money which would increase in value over time. With each year that passes, the rate of return gets faster.

In this blog I want to explain the concept of Compound Growth and demonstrate why it’s so valuable. I’ll also talk about how compound growth can help predict how long it will take you to reach your financial goals.

What Is Compound Growth?

Compound growth can be very powerful and get you to a high return faster than other methods. In simple terms, when you invest your money, you will earn returns on both the original sum and any accumulated returns that came before it.

Why Is Compound Growth So Important?

Compound growth is so important because it makes money work for you. You don't have to rely on additional income or a pay rise to make more money. The earlier you start, the more time your money has to grow on itself. This means that if you can invest a small amount in your 20s and leave it alone, the amount will grow exponentially over time, and the return on your investment will become much higher than your original capital.

The real power of compound growth lies in not having to add anything to your initial capital sum. This allows you to live a simpler, more peaceful life that is free from the stress of constantly looking for new sources of income or new ways to make money.

How Does Compounding Work?

Most people start their careers with this mindset: When you have a job, you work for a month and get paid for a month's worth of work. You only get paid for the work you did that month once—there's no carryover.

That's why your earnings through employment tend to be linear.

But what if your earnings weren't so linear? What if, instead of getting paid for one month of work just once, you got paid for that month of work plus extra portions of previous months? In other words, what if your earnings were to compound?

Let's say you worked one month and then got paid for that month. Then, once the next month rolled around, you got not only paid for the new month's work but also an extra portion of last month. Then in the third month, you not only got paid for that third month but also an extra portion of the first and second months. As each new month passes, the value of one month's work increases exponentially.

Show Me the Money!

Here’s a quick example with some maths for you to get a clearer picture of compounding in action.

Let’s say you had £1,000 to invest each year into an account with an annual interest rate of 10%. After year 1 you would have £1,100 in the account. (£1,000 x 1.1) You would end year 2 with £2,310. (£2,100 x 1.1) This is because the amount you already have in the account (£1,100) is combined with your new contribution of £1,000, then the annual interest is applied. By the end of year 3, your account value would be £3,641. (£3,310 x 1.1)

I could go on, but I think a graph would illustrate this better.

When your account is first opened, the amount you contribute might seem like a lot. But as time passes and the total value of your account increases, the amount of money you contribute is less and less significant when compared to what you are saving.

It's understandable if this all sounds a bit overwhelming, but the good news is that once you've done the hard part of starting to invest, you can sit back and watch your money work for you. So whether it's a rainy day or retirement you're looking to save up for, starting sooner than later can go a long way towards making your financial goals easier to achieve.

If you're struggling to find the right products to fit your needs, I can help you to gain a deeper understanding of how the various opportunities out there can help you to grow your wealth.