Forget about location, location, location being the key to a good investment outcome. The key ingredient is time, time, time, which delivers the ‘magic’ of compounding.
Over time, a regular savings plan can turn small amounts of money into a larger sum that brings you closer to achieving your goals, faster. For example, let’s see what happens to an investment starting with just $100 and adding $100 each week. The table below shows what the investment value would reach after each five years, up to thirty years. For simplicity, in this example, we have assumed that the investment pays a return of 5% per annum (paid monthly).
Table 1: Initial investment of $100 plus a Regular savings plan of $100 per week compounding monthly. (Returns do not account for any tax payable market fluctuations or product fees)1
Compounding is how a regular savings habit can turn small sacrifices into real outcomes. In return for this self-restraint you can see what can be achieved:
- $29,000 in 5 years might go towards a deposit on your first home or an overseas holiday;
- $67,000 in 10 years might contribute to a child’s secondary or tertiary education; or
- $258,000 in 25 years might help you to retire more comfortably or earlier than you thought you could.
Any of these goals would seem to make your small sacrifices extremely worthwhile in the long run. Remember to write down your financial goals because it’s much easier to make better financial choices if you can visualise what they are helping you achieve.
Reducing expenses is not the only way to find a spare $100 each week. Another good time to start a savings plan is when you increase your income from a new job or a pay rise. Before you spend the extra money, have it automatically put away.
The trick is to start soon
Everyone’s ability to save is different. If you can’t save $100 every week, the above figures are still worthy of your attention. For example, if you can save $50 per week, halve the results in Table 1. Conversely, if your savings capacity is higher, then multiply the figures accordingly.
The results demonstrate the effect of time and compounding returns on the value of your investment.
Remember, the sooner you start, the less you need to save in order to achieve the same outcomes.
The difference 10 years can make!
Christine plans to retire in 20 years so she starts saving an extra $100 per week. Based on the above simple calculations and assumptions, she might expect to have an investment of around $178,000 to add to any other superannuation or retirement benefits she has at that time.
Christine’s twin Ben also plans to put down the tools in 20 years, but he is confident that he can save more money than his sister. So Ben ignores any type of retirement planning for the next 10 years. He then saves twice as much as Christine – $200 per week – for the last 10 years of his working life.
Assuming the same 5% return on the investment with interest being paid monthly, the difference is staggering. By starting 10 years earlier, Christine will have saved just over $178,000 compared to Ben’s outcome of $134,743.
Even though his regular savings amount totals exactly the same as his sister’s ($104,000 throughout the investment period), Christine has benefited from the compounding investment returns on her money over a longer period of time, earning an extra $44,000 in interest. Another way to look at it is that Ben would need to save $265 per week for the last 10 years of his working life (a total of $137,800) to end up with the same outcome as Christine.
Important to note…
The examples we have used here highlight the benefits of time when it comes to investing. To keep things simple, we have not accounted for other factors that will impact the outcomes you can achieve, such as taxation, fees, market fluctuations and differing investment returns.
These factors are nonetheless important and will need to be considered when you are deciding on the type of investment that best suits your needs. The type of investment that is best for you will depend on your own specific circumstances, including your goals, investment time frames and attitude to risk (volatility).
You can start a compounding savings plan on your own, or talk to us. We may be able to show you more options to help you achieve your goals even sooner.
The information contained in this article is general information only. It is not intended to be a recommendation, offer, advice or invitation to purchase, sell or otherwise deal in securities or other investments. Before making any decision in respect to a financial product, you should seek advice from an appropriately qualified professional. We believe that the information contained in this document is accurate. However, we are not specifically licensed to provide tax or legal advice and any information that may relate to you should be confirmed with your tax or legal adviser.
1 https://moneysmart.gov.au/budgeting/compound-interest-calculator
