PLANNING
Compounding: The 8th
Wonder of the World
It is unlikely that Einstein ever used this phrase, but it serves to make a point.
Compound interest can be thought of as interest on
interest or growth on growth and will make a sum of
money grow at a faster rate than simple interest or
growth, which is interest calculated only on the
original investment amount.
The rate at which compound interest accrues
depends on the frequency of compounding; the
higher the number of compounding periods, the
greater the compound interest.
Therefore, if your investment grows at 5
per cent a year on average for 25 years,
£10,000 would eventually be worth
£33,684.
Using the same example and using a figure of 2 per
cent compound interest a year, then the same
£10,000 would be worth £16,406 after 25 years.
As you know, there are no guarantees on either
savings rates or investment returns, but historically the
rates of return from investments have always been
higher than those from cash over the longer term.
Key points
Compounding means you get growth on
your growth
Long-term investing exposes you to a
greater period of compounding
The rate of compounding on cash is relatively small at
the moment as interest rates are set at 0.5 per cent
and are forecast to stay low for the foreseeable future.
“Compound interest is the
Eighth Wonder of the
World” Albert Einstein
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