He may be best known for E=MC2, but Albert Einstein’s genius helped shape the modern world. From GPS to refrigeration his thinking has been groundbreaking.
It is less well known that his thinking included finance, and in particular, compound interest – which he purportedly referred to as the 8th wonder of the world.
The power of compounding is the ability of an investment to generate earnings not only on the original investment but also on the accumulated interest or earnings.
This means that the longer the investment is held, the more significant the impact of compounding becomes.
At Continuum we are looking at the power of compounding to build substantial wealth over the long term.
What is compounding?
Essentially, compounding involves generating earnings not only on your initial investment each year, but also on the interest or returns from previous years. This creates a snowball effect where your wealth grows exponentially over time.
It’s easier to understand with an example. Imagine two individuals, Albert and Bill. Both decide to invest £10,000 in a fund that offers an annual return of 7%. Both receive exactly the same rate of return, which nets them each £700 in the first year. However, Albert reinvests his earnings while Bill withdraws his earnings each year.
After 10 years
At the end of 10 years, Bill’s investment would have delivered around £17,000. This is a significant increase from his initial investment of £10,000 – but Albert’s investment would have grown to around £19,670.
The £2,670 difference demonstrates to the power of compounding.
But the phenomenon that so delighted Einstein has only just started.
After 25 years
After 25 years Albert’s initial investment of £10,000 would have ballooned to approximately £54,274.33. Bill’s investment, still earning the same return but without compounding, would have netted only about £27,500.00.
The gap between their investment values has widened significantly over the years. Because Albert harnessed the power of compounding, his wealth is growing at an accelerating rate. In contrast, Bill’s investment still delivers at a steady £700 a year.
After 30 years
A 30-year timeline showcases the astonishing long-term effects of compounding. Albert’s investment of £10,000 would have transformed into an astounding £76,122.55. Bill’s returns would pale in comparison at just £31,000.00.
The difference in wealth is staggering – a substantial £45,122.55 – all due to Albert’s strategic use of compounding. Over this extended timeframe, compounding has worked relentlessly to exponentially increase her wealth, solidifying Einstein’s assertion that compound interest is indeed a wonder.
Time really is money
The longer you can stay invested, the more compounding can do for you. To make the most of compounding, consider these steps:
Start Early: The earlier you begin investing, the more time your money has to compound. Even small contributions can lead to significant growth over time.
Reinvest Earnings: Whenever possible, reinvest dividends, interest, and capital gains. This accelerates the compounding process and magnifies your returns.
Diversify: Spread your investments across various asset classes to mitigate risks and tap into multiple compounding avenues.
Stay invested: Compounding is astonishingly powerful, but it is not a get rich quick scheme. It requires patience and a long-term perspective to fully realise its potential.
Get expert help: The astonishing power of compounding is too good to waste on mediocre investments. You need to have your money in funds and holdings that can offer security and consistent prospects for real returns.
Fortunately, you don’t need to be an Einstein to find the investments with the most appeal and potential rewards. Simply call us at Continuum to build an investment strategy that can potentially help make your money grow for you.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested.