The power of the compounding effect

Meet Jennifer and Alex, two individuals with different approaches to long-term investing. In this example, we’ll explore how their investment choices, and the ‘compounding effect’ can make a significant difference in their financial futures. For this exercise, we will assume they both receive the same average annual return of 7% p.a. on their investments.

Jennifer has a good understanding of the value of time and starts investing at a young age, beginning at 20 years old. She diligently contributes $100 each month into her investment account until she reaches the age of 65.

Alex, on the other hand is a ‘late bloomer’ and starts investing at a later stage, age 35. To compensate for the lost time, he decides to invest larger monthly contributions of $250 each month – more than double the size of Jennifer’s contributions. Will Alex’s increased contributions be enough to bridge the gap? 

Let’s fast forward to the age of 65 and discover the difference in the end balances of their investment accounts.

The difference between Jennifer and Alex’s end balances are eye-opening. Even though Alex contributed more each month, Jennifer’s early start allowed her investments to benefit from the magic of compounding over a more extended period. As a result, Jennifer’s end balance significantly outpaces Alex, showcasing the real power of starting early and having a long-term approach.

Compounding is like a snowball rolling down a hill, gaining momentum as it grows. In Jennifer’s case, her regular contributions combined with the power of compounding allowed her investments to generate more returns over time. The compounding effect occurs when the earnings from an investment are reinvested, leading to additional earnings on top of the original investment and previous earnings.

As Jennifer contributed each month, her investments not only earned returns on the initial deposit but also on the accumulated returns from previous months. This compounding snowball effect gradually accelerated, resulting in a significantly larger final balance of $379,259.

On the other hand, although Alex made larger contributions, he had a shorter period for his investments to compound. As a result, his final balance of $304,993 was lower compared to Jennifer’s.

Jennifer’s story beautifully illustrates how starting early in the world of long-term investing can create a substantial advantage. By consistently contributing smaller amounts over a more extended period, she was able to build a significantly larger nest egg compared to Alex, who started investing later in life.

This example serves as a gentle reminder to our valued clients that time truly is money when it comes to investing. Embrace the opportunity to start early, even with modest contributions, and let the power of compounding work its magic for your long-term financial success.