Thursday 5 February 2015

3 case studies to show the power of Compound Growth

Many of my friends know that I invest in the stock market. None know quite the extent to which I am investing (for reasons which become clear after reading the experience of Jason Fieber at Dividend Mantra).

Even without knowing how much I have invested many ask why I am putting aside any money now in my mid-20s when I will presumably have a higher income--and thus more money to spare--in the future. My simple answer--as I am sure most people reading this will appreciate--is compound interest.

One friend in particular could not see how powerful this was after I explained it. As a result, I agreed to send them a series of links about it. Still unconvinced I put together a handful of (fictional) case studies to prove my point. As it finally convinced them, I thought it may be of use to publish it for others to see.

First, let's start by being a little unusual and give you the punch line of this post. What does it seek to prove? Chiefly three things:
  1. Starting early in investing/saving money is critical for optimising gains;
  2. If you start early you can have periods when you can't set aside money and yet still reap the rewards;
  3. You don't need to have large sums set aside but can slowly set aside small amounts of money
Hopefully you will find it of interest. Maybe it will even serve as a useful way of convincing others!

My Three "People"

I have assumed that each person has set aside a certain amount (specified later) and then invested it at the start of the year.

I have also assumed that the annual growth is 5%. Of course, in real life some years would be higher than that and others lower. Similarly, the likelihood is that the actual annualised growth would be higher than this (supposedly since its inception in 1984 the FTSE 100 has delivered an average growth of 17%).

Person A: Consistent Claire

Consistent Claire has a highly consistent, unbroken investing regime. She invests £100 every month from the age of 25 onwards. She continues to do so until her retirement at 65. This is how her portfolio would look in terms of value over that 40 year period:


AgePerson A: Consistent Claire
ValuePaid In
251,260.001,200
262,583.002,400
273,972.153,600
285,430.764,800
296,962.306,000
308,570.417,200
3110,258.938,400
3212,031.889,600
3313,893.4710,800
3415,848.1412,000
3517,900.5513,200
3620,055.5814,400
3722,318.3615,600
3824,694.2816,800
3927,188.9918,000
4029,808.4419,200
4132,558.8620,400
4235,446.8021,600
4338,479.1422,800
4441,663.1024,000
4545,006.2625,200
4648,516.5726,400
4752,202.4027,600
4856,072.5228,800
4960,136.1430,000
5064,402.9531,200
5168,883.1032,400
5273,587.2533,600
5378,526.6234,800
5483,712.9536,000
5589,158.6037,200
5694,876.5338,400
57100,880.3539,600
58107,184.3740,800
59113,803.5942,000
60120,753.7743,200
61128,051.4544,400
62135,714.0345,600
63143,759.7346,800
64152,207.7248,000
65161,078.1049,200

As you can see, Claire would have invested £49,200 over that period and would be sitting on a pot worth £161,078.10. That is a return of over 327%.


Person B: Late Luke

Late Luke is slow to start investing. He does not start investing until he hits 40. However, when he does he sets aside £250 per month until he retires at 65. He thus invest £150 more per month than Claire but much later. This is how his portfolio value looks over that 25 year period:

AgePerson B: Late Luke
Value (£)Paid In (£)


403,150.003,000
416,457.506,000
429,930.389,000
4313,576.8912,000
4417,405.7415,000
4521,426.0318,000
4625,647.3321,000
4730,079.6924,000
4834,733.6827,000
4939,620.3630,000
5044,751.3833,000
5150,138.9536,000
5255,795.9039,000
5361,735.6942,000
5467,972.4845,000
5574,521.1048,000
5681,397.1551,000
5788,617.0154,000
5896,197.8657,000
59104,157.7660,000
60112,515.6463,000
61121,291.4366,000
62130,506.0069,000
63140,181.3072,000
64150,340.3675,000
65161,007.3878,000

As with Claire, Luke ends with a similar sized final pot of £161,007.38. However, in contrast to Claire, he has had to invest £78,000 in order to achieve this figure. This is nearly £30,000 more than Claire had invested. He has thus had to invest 63% more than Claire to get the same return whilst also having to set aside more each month to do so.

Consequently whereas Claire had a return of 327%, the return for Luke sits much lower at just over 206%. Still a nice figure certainly but much lower than Claire's.

Person C: Inconsistent Ian

Ian starts investing £150 per month from the age of 25. However, due to various reasons from the age of 35 through to 50 is forced to stop putting anything additional aside for investing but does leave his previously invested money to work for him.

However, from aged 50 he begins investing £150 per month once again. His portfolio return for this broken 25 year period looks like this (italics are the years in which no additional funds are added):

AgePerson C: Inconsistent Ian
Value (£)Paid In (£)
251,890.001,800
263,874.503,600
275,958.235,400
288,146.147,200
2910,443.449,000
3012,855.6210,800
3115,388.4012,600
3218,047.8214,400
3320,840.2116,200
3423,772.2218,000
3526,850.8319,800
3628,193.3719,800
3729,603.0419,800
3831,083.1919,800
3932,637.3519,800
4034,269.2219,800
4135,982.6819,800
4237,781.8119,800
4339,670.9019,800
4441,654.4519,800
4543,737.1719,800
4645,924.0319,800
4748,220.2319,800
4850,631.2419,800
4953,162.8019,800
5055,820.9419,800
5160,501.9921,600
5265,417.0923,400
5370,577.9425,200
5475,996.8427,000
5581,686.6828,800
5687,661.0230,600
5793,934.0732,400
58100,520.7734,200
59107,436.8136,000
60114,698.6537,800
61122,323.5839,600
62130,329.7641,400
63138,736.2543,200
64147,563.0645,000
65156,831.2246,800

Despite the break, Ian still ends up with a pot worth £156,831.22 (only a little less than Claire or Luke). However, she has only invested £46,800 over that period--less than both Claire or Luke. As a result, she has seen a return of over 335%.

Start as soon as possible!

So what does this tell us? Well, quite simply, get started early. Even with a break from investing in between you can still expect significant returns if you invest earlier rather than later: even with a small amount.

Similarly, you can invest small amounts and still get huge rewards from it. Even I was amazed by the stark (and exciting) reality that these case studies show up. The quicker you realise this the better. It is just a shame that so many are missing out on this remarkably powerful and simple action. I was myself until little over a year ago!

[Creative commons image reproduced from Flickr user SumAll]

No comments:

Post a Comment