Investing for the long-term: The power of compounding returns
As a financial advisor, one of the things I hear most often when talking with clients about starting an investment plan is “I don’t have much to invest now so maybe next year”. The common perception is that if you don’t have a lot to invest now, it’s better to just wait and contribute more later.
In fact, the opposite is true. One of the best ways to build wealth is to start investing early – even if it’s only a small amount. It’s hard to find the motivation to start investing when you’re young, which is why a lot of people put it off until they’re further along in their career.
I always find this concept easier to understand with an example. Let’s look at the difference in returns between two people who start investing at different times. Meet Sue and John; they both invested money but started investing at different times.
Sue started investing 20 years ago. She made 10 annual contributions of $5,000 (total of $50,000) and received an 8% annual return. She stopped investing after ten years and held on to the investment for a further ten years, at an 8% annual return.
John started investing 10 years ago. He made 10 annual contributions of $10,000 (total of $100,000) at the same 8% annual return. In total, John has contributed twice as much money to his investment account.
Time for the quiz, who do you think has more money in their investment account? If you answered Sue, you are correct! Despite contributing $50,000 less in total, Sue’s account is currently worth ~$13,000 more than John.
The above example is meant to illustrate an extremely important concept: the sooner you invest, the more time your money can grow and benefit from the power of compounding. Although they both contributed money to their investments for the same amount of time, and John put in more money per year, Sue ended up with more. How? Sue’s money got a head start and was growing at 8% annually for ten years before John started investing. John’s larger contributions later in life were no match for the power of compounding returns. There is an old saying in investing - The best day to start investing was yesterday, the second best day? Today.
Riley Love, MBA, CCS, BSc. Pharm
Financial Advisor – Love & Persson Group