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How you can make the magic of compound interest work for you

Apr 15, 2020 | Investing

With a heavy push from the government to start investing for your future by way of pension plans to help the ever-increasing number of retired people, it’s wise to be thinking about your future as early as possible.

Due to the nature, and magic, of compounded interest your investment grows at a much higher rate the earlier you start.

Compounded interest is not the easiest to explain but think of it in terms of interest on your interest. Let’s say, for example, you invest £2,000 in year one that has a return of 7% of your investment. This means by the end of year one you have £2,140. Now without touching anything you take £2,140 into year two in which you again earn another 7%. By the end of year two you will have £2,289.80.

You were given interest of 7% in year two on the £140 interest you earned in year one (plus of course your original £2,000 investment). You earned interest in year two on your interest from year one – and this is what is meant by compounded interest.

At the end of year three you will have £2,450.09 – and you will still be earning interest on the interest made in year one (£140) and year two (£149.80). Another example of compound interest. I hope you’re still with me.

Although this so far has nothing to do with an investment book round up, what this does highlight is the need to start today. Continuing with the values above, after 20 years you would have £7,739.37 but surprisingly after 40 years this isn’t worth around £14,500 (double the amount as we have doubled the years), it would actually be worth £29.948.92!

And at 50 years (just 10 years later) it would be worth £58,914.05. The sooner you start the longer you have for your interest to compound and the higher your returns.

Ok, maths lesson over. The lesson of the story though is – your investment grows exponentially every year. The table below gives you a good visual interpretation of a scenario of investing £100, £1,000 and £10,000 at the age of 20, 40 and 50 years old and how much your investment pot would be worth at the age of 70. It gives a stark warning to those planning to start an investment fund to start today!

 

Invest £100 from the Age of 20 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£100£100
End of Year 1£100£107
End of Year 30£100£761.23
End of Year 50£100£2,945.70

 

Invest £1,000 from the Age of 20 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£1,000£1,000
End of Year 1£1,000£1,070
End of Year 30£1,000£7,612.26
End of Year 50£1,000£29,457.03

 

Invest £10,000 from the Age of 20 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£10,000£10,000
End of Year 1£10,000£10,070
End of Year 30£10,000£76,122.55
End of Year 50£10,000£294,570.25

 

 

Invest £100 from the Age of 40 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£100£100
End of Year 1£100£107
End of Year 15£100£275.90
End of Year 30£100£761.23

 

Invest £1,000 from the Age of 40 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£1,000£1,000
End of Year 1£1,000£1,070
End of Year 15£1,000£2,759.03
End of Year 30£1,000£7,612.26

 

Invest £10,000 from the Age of 40 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£10,000£10,000
End of Year 1£10,000£10,070
End of Year 15£10,000£27,590.32
End of Year 30£1,000£76,122.55

 

 

Invest £100 from the Age of 50 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£100£100
End of Year 1£100£107
End of Year 10£100£196.72
End of Year 20£100£386.97

 

Invest £1,000 from the Age of 50 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£1,000£1,000
End of Year 1£1,000£1,070
End of Year 10£1,000£1,967.15
End of Year 20£100£3,869.68

 

Invest £10,000 from the Age of 50 at an average of 7% per annum

AtOriginal InvestmentInvestment Fund Amount
Start£10,000£10,000
End of Year 1£10,000£10,070
End of Year 10£10,000£19,671.51
End of Year 20£10,000£38,696.84
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