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  • Writer's pictureMichael Roberts FPFS

The amazing power of compound interest

Updated: Mar 21, 2020

Consider the following two guys. Dean and Dan. Both age 25 they have studied together at uni and are now entering the world of work.

Dean starts his first job straight away. He joins the company pension and contributes £3,000 per year. Let's assume the pension performs reasonably well and grows at 6% pa. At the age of 40, Dean decides to set up his own business, and stops paying into his pension. He never pays in a single penny ever again (his financial planner was horrified!).

Dan on the other hand sets up his own business when he leaves uni, but it takes years to get established. Finally, age 41, he has enough money left to start his pension savings. Again, he contributes £3,000 per year, but he keeps paying in until he retires age 65. The pension achieves the same growth as Dean's; 6% per year.

In total, Dean has paid in £48,000. Dan by comparison has paid in £75,000; over 50% more than Dean. The pensions have grown at exactly the same rate each year. So why, then, is Dean's pension valued at £313,000 by the time he retires age 65, whereas Dan's is worth just £153,000; less than half the value of Dean's? It's all down to the power of compound interest.

The more money you can save, and the sooner you start saving it, the better. The continual growth upon growth, rolling up within the account, accumulates over time like a giant snowball.

The sooner you can start saving the better, and not just for yourself; helping Children or Grandchildren on the savings ladder can make an enormous difference. Maybe they won't thank you today for starting to pay into an ISA or pension for them. But someday they will, and it will likely make a huge difference for them.

It's a bit like the old story of doubling a penny for 30 days. If you take just one penny, and every day, you double it, how much do you have at the end of the month? Amazingly, you'd have £5.3m. Ok so it's not every day you stumble upon an investment that doubles in value ever day for a month, but you get the idea.

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