Compounding occurs when you invest regularly, over a long period, and the growth on your investments, such as dividends/interest/capital gains, is itself reinvested to generate returns. Even if you invest a small amount per month and gains are made on this small amount, you will find it can grow to a worthwhile nest egg for your future self.
Examples of Compounding
For example, if you invest £1,000 pcm over 10 years you will have paid a total of £120,000 into your pension pot. Under current legislation, these contributions are made before tax is taken off. So, if you are a marginal 40% higher rate taxpayer, your future self is already £48,000 better off over that period. Looking at it another way, you have given up spending £600 per month now (after tax) to save £1,000 per month in your pension. If you are in a higher tax bracket, the amount your present self gives up every month is even smaller in relation to the amount your future self could gain through the pension investment.
Applying a constant 4% basic investment growth* over the 10 investment years gives a pot of £147,249.80 at the end of the 10-year investment period. This is the starting point for the examples below. (On this basis, a £400,000 pot would have a value of £490,832.64)
Because of compounding, your pot will grow to different amounts depending on which 10 years you use.
If you are contributing from age 45 to 55 and you leave your funds invested, with an average yearly compound return of 4% until retirement at 65, your final investment pot should grow to be worth around £217,966 by retirement.
Following this example, see the simplified table below with average growth rates of 4%, 5% and 7%.*
|
Age at start and end of contribution period |
Years to retirement from end of contribution period |
4% |
5% |
7% |
|
25-35 |
30 |
£477,589.65 |
£636,405.17 |
£1,120,903.07 |
|
35-45 |
20 |
£322,642.45 |
£390,697.57 |
£569,810.28 |
|
45-55 |
10 |
£217,965.68 |
£239,854.42 |
£289,662.65 |
When investing in any market, you should always be aware that there is a risk that at any single point in time, your investments may be worth less than you paid for them.
