Investment managers have crunched some numbers to show how the magic of compound interest can boost retirement savings.
The example looks at two investors.
One starts saving £1,000 a year from the age of 18 until he is 38 years old. The other saves £1,000 a year from the age of 38 until they are 65-years-old. The difference between their cash pile on retirement at the age of 65 is huge.
The first investor has £34,719 in savings by the age of 38 with the cash they have banked and an annual return of 5%.
Even though he saves nothing more to the age of 65, the investment continues to generate a 5% return each year.
Due to compounding, over those years his savings grow exponentially and dwarf the original amount. By the time he is 65, the investment has grown to £129,623.
The second investor saves £1,000 a year with a 5% return but only amasses savings of £57,403 – not even half of that saved by the other investor.
The difference, says fund manager Fidelity International is time. The first investor saw interest compounded on his account every year between when he was 18 and 65. The second only had the benefits of compounding between the ages of 38 and 65.
Tom Stevenson, investment director for personal investing at Fidelity International, said: “Compounding is an incredibly powerful force that can make an enormous difference to your savings and investments. It’s small wonder then that Albert Einstein called compounding the eighth wonder of the world.
“As our calculations show, the sooner you invest, the more time your money has to grow and the greater the impact of compounding will be. On the other hand, if you choose to put off saving into an ISA or pension by just a few years you could end up forever playing catch up. This can have a huge knock-on effect on your ability to reach your financial goals or have a comfortable retirement. With this is in mind, it’s sensible to start to save as soon as you can.”
How compounding works for two investors
Source: Fidelity International