Harmy Bains explains the power of compound growth, Einstein’s eighth wonder of the world.
A robust financial plan is crucial to help ensure a comfortable retirement and financial security. One of the most potent tools for achieving these goals is compound growth.
According to Albert Einstein: ‘Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.’
As this concept can help amplify your investment returns over time, it could prove beneficial to understand it.
Compound interest occurs when the interest earned on an investment is reinvested, generating additional interest on the original investment and the accumulated interest.
This creates a snowball effect that can dramatically increase your wealth. The diagram above illustrates this using a 10% compound return.
Key factors affecting compound interest
Several factors influence the rate at which compound interest grows, such as the initial amount invested, the percentage return on the investment, the length of time the investment is held and how often the interest is added.
Investment options
Dentists have a variety of investment options depending on whether they are self-employed or a limited company, each with its own risk-return profile:
- Pension schemes, including NHS Pension and private pension plans, offer tax advantages and can be a great way to save for retirement
- Individual savings accounts (ISAs) provide tax-free investment opportunities
- UK government bonds, also known as Index Long Term Strategy (ILTS), benefit taxpayers at a higher or additional rate as they offer no capital gains tax to pay on profits coming directly from the increase in the bond price
- Investing in property can provide both income and capital appreciation.
When considering your investment options, it is important to understand how the different options work together to create your long-term financial plan, considering wealth flow over time.
Diversification and risk management
To manage risk and help maximise returns, it’s important to diversify your investments across different asset classes and industries to help protect your investment portfolio from market fluctuations.
The importance of maximising growth rates
Let’s assume you invest £1,000 per month in a portfolio historically averaging a return of approximately 9% per year compared to one that returns 5% per year, according to thecalculatorsite.com:
- At 9%, it would grow to circa £613,000 over 20 years
- The same investment, at 5%, would grow to circa £396,000 over 20 years.
This highlights the power of compound growth and how important it is to maximise the return on your investments to take full advantage of it.
Delaying investment inevitably has an impact. To illustrate the influence of early investment, if you delay starting the previous example investment by five years, it would be worth approximately £352,000 after 15 years – costing you £261,000 in potential growth. These are hypothetical examples; actual returns may vary.
It’s essential to consult with a financial planner to help create a personalised, comprehensive investment plan that aligns with your goals and risk tolerance. While you can learn a lot about compound interest and investing on your own, consulting with a qualified financial planner can provide valuable guidance and personalised advice.
Key takeaway
The power of compound growth can have a major impact on your ability to meet your financial goals. Time is your friend when it comes to investing. The longer you invest, the more significant the benefits of compound growth become.
Regularly contributing to your investments, as early as possible, can boost your savings, helping you build a comfortable nest egg for the future.
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