The early bird catches the compound interest

At Wellesley we offer financial advice across a broad range of areas – from retirement preparation to inheritance tax planning – and this advice is carefully tailored to each individual client and their aspirations. However, one piece of advice we offer is consistent across the board: the sooner you start saving for the future, the better.

Taking a long-term view

It can be easy to put off saving for retirement – especially when there are more immediate financial matters to attend to, such as paying off your mortgage or funding a child’s tuition fees. But the earlier you start saving means that your savings pot will have more time to grow.

Albert Einstein reportedly called compound interest the “eighth wonder of the world”, saying: “He who understands it, earns it; he who doesn’t, pays it.” Investing success results from the way that investment returns themselves generate further gains. Reinvesting any income generated, means that the returns in the next period are earned on the invested sum – plus the previously accumulated income. This ‘snowball effect’ isn’t just an apt topic for a chilly January – it is a powerful metaphor when it comes to making the most of compounding returns: once your savings pot is ‘rolling’, the more it collects and the bigger it gets.

Despite this, the power of the compounding concept is often overlooked by those who are saving for the future.

Why starting early pays off

It’s never too soon to start thinking about the future and what you want your retirement to look like. Saving from an early age can help you reach your goals sooner, as shown in the chart below, which illustrates just how much difference compounding could make when someone starts saving earlier (source: SJP).

In this example, Daisy starts saving £200 a month when she is 25; Ken saves £400 a month from the age of 45. In total, they both save £96,000 by the age of 65. However, assuming an illustrative growth rate of 5%, Daisy ends up with almost twice as much as Ken due to 20 extra years of compounding returns. Please note these figures are examples only.

Company shares

Reinvesting dividends paid from company shares provides a powerful example of how compounding can boost investors’ total return. Figures from Barclays show that a notional £100 invested directly into UK shares at the end of 1945 would now be worth £10,933 in nominal terms, without the income reinvested; but would have grown to £238,690 if the dividends had been reinvested in more shares (source: Barclays Equity Gilt Study, 2018). However, it is worth noting that past performance is not indicative of future performance.

Kickstart your saving

To conclude, by getting into the savings habit sooner (and becoming the proverbial ‘early bird’!), the bigger your savings pot will grow and the more secure your financial future will be. Younger generations may nowadays face even greater financial challenges, but they have got time on their side, making building a savings pot more achievable.

That’s why it also makes sense for families thinking about intergenerational planning to help children and younger adults make an early start by saving money through Junior ISAs, ISAs and pensions. Here at Wellesley we can help you create a plan for saving that you are happy with, ensuring that you can actively look forward to your retirement.

For more information

If you have a question about planning for the future or would like more information about our services, please contact Wellesley Wealth Advisory on 01444 848508 or via email at info@wellesleywa.co.uk.

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