Compounding
Compounding is your most powerful tool in investing, but it can be the easiest to overlook. Getting your head around it is the hardest part – after that, it does the work for you.
Important notes
This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.
Imagine this. If you fold a piece of paper in half 27 times, it will be taller than Mount Everest.
And if you folded that paper just a few more times, you would reach the moon.
It seems counter-intuitive, but it’s true. And if you can get your head around the concept, it will prove to be one of the most important lessons you’ll ever learn about investing.
Fold the paper once – it’s two sheets thick.
Fold it twice, it’s four sheets thick. A third time and it’ll be eight sheets thick. By the seventh fold you’ll start running into difficulties – but it would be 128 sheets thick. By the ninth fold, it’d be as thick as an entire pack of paper. At this point, though, it’s still only a few centimetres high.
But by the 27th fold – your piece of paper would be over 10km high (which is taller than Mount Everest).
How is that possible? Because each fold effectively doubles its height, which is tiny at first - just a few sheets thick - but as you keep folding, your piece of paper soon becomes miles tall. You’re not starting again each time – you’re building upon a base that already exists.
This is how that looks:
How paper can reach the moon with compounding
It takes a long time to notice something is happening, but when it does, the effect is huge. That’s the power of compounding.
It’s easy to overlook something so small because it’s hard to understand how it ever gets so big.
This article is not personal advice. All investments can fall as well as rise in value so you could make a loss. If you are unsure whether an investment is right for you seek advice.
Small is powerful
Our data for the UK’s stock market goes back to 1986. Since then, it’s grown 1900%, turning £100 into £2000. But day-to-day, it’s only gone up 52% of the time. Which means two things.
- For all the days you invest, you should be prepared for the market to fall 48% of the time.
- It’s the tiny margin of better days, just 4%, which compounds over time to multiply your money by 20 times.
Remember though that past performance is not a guide to the future and there are no guarantees.
Just like the single sheet of paper which grew taller than Everest – never underestimate the power of small things.
Compounding in investing
Compounding is just as applicable to money as it is to paper. Regularly investing small amounts of money, letting any increases build upon themselves, and not touching it for the long-term takes patience – but the results could really pay off.
The figures shown in this video aren’t guaranteed. And they don’t take inflation or charges into account.
The first rule of compounding: Never interrupt it unnecessarilyCHARLIE MUNGER
How to benefit from compounding
The best thing about compounding is that you don’t really need to do anything to benefit from it once you start. In fact, it works best when you do nothing. Just leave your money invested.
So long as you check you’re diversified enough, and your investments are still in line with your goals, time will do the work. And one of the best ways to start benefiting is by investing monthly.
Why invest monthly
- It takes the emotion out of your decisions
The stock market will always go up and down, and you’ll always want to buy when the price is low, and sell when it’s high. If every investor could do this successfully, the world would be a very different place. Investing automatically gets you out of the mindset of having to ‘time the market.’
- You’ll benefit from ‘pound-cost averaging’
Investing automatically helps smooth out the bumps in the market, taking the emotion out of your choices and spreading your money across different market conditions. Sometimes, you’ll buy at a higher price, and other times it could be lower – but you won’t have to worry about the timing. Over time, these ups and downs tend to average out.
- It’s good investing discipline
Setting aside money automatically makes it easier to get into good habits. You won’t forget to invest, because it happens at the same time every month, and any growth will compound upon itself. Leaving the money alone can be hard, and takes patience, but the results can really pay off over time.
Find out more about investing monthly by Direct Debit
- Start as soon as you can, start small, and do it regularly
- Reinvest your profits – they’ll add to your base
- Don’t interrupt it
The results might surprise you.