• Serendipity Team

Waiting for the right time to invest? It could be costing you thousands.

When it comes to creating wealth, there are two main rules you need to follow: First, you need to make sure that your money is not losing value due to inflation. The second, is taking advantage of compound interest.

While these are straight forward concepts in theory, many people don’t follow them because they fall into the trap of waiting too long to start investing. In doing so, they make growing their wealth, harder than it needs to be, purely because they don’t understand the power of compound investing.

As Albert Einstein is reported to have said “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”.

In this article we will explore the power of compound interest and why starting sooner rather than later can make a significant difference to your future.

What is compound interest?

Compounding is essentially the concept of earning interest on top of interest. For example, with an online savings account that pays interest every month, if you’re not withdrawing that money, you’re earning interest on top of interest. This is in contrast to simple interest, where interest is not added to the principal, so there is no compounding. Instead, interest is paid at the end of the investment period as a one-off. The same principle also applies to shares. With shares you earn income from dividends (distribution of company profits), and this is money you can then reinvest to acquire more shares and earn even more in dividends.

Should you invest a little now or more later?

A common dilemma many clients have is whether they should wait until a better time to invest. The power of compounding though means that the longer you wait, the more you will need to invest and the less you will earn in the process.

Let’s take a look at an example to illustrate this point.

Let’s say our imaginary client, Sarah, is deciding whether to invest. She is 5 years into her 30-year mortgage and has decided that over the next 25 years she wants to grow her wealth. She is deciding between investing $5,000 a year now for 10 years and leaving her portfolio to grow on its own, or investing $10,000 a year for 10 years in 15 years time. Let’s assume that Sarah’s investments achieve an average annual return of 8%.

If she goes with option one and invests $5,000 a year for 10 years, it means she will invest a total of $50,000 and based on an 8% return she will have $248,000 in 25 years time. If she goes with option two and invests $100,000 over 10 years, despite investing twice as much she will only have $156,000 in 25 years time. That’s a $92,000 difference! The reason for this difference is that her money had more time to grow in the first scenario. Take a look at the table below:

If we use the same example but the returns average out at 6% per year, she will have earned close to $28,000 more by starting early. If her returns are higher and average at 9% per year, she will have earned $136,000 more.

While predicting the rate of return on any investment is near impossible without a crystal ball, there is one guarantee and that’s compound interest. In other words, the key to growing your wealth lies less in the amount you invest and more in the amount of time your money has to grow and compound over time.

Developing a growth mindset

While understanding the power of compounding is important, it is just one aspect of what it takes to successfully grow your wealth. The other aspect is having the right mindset. Investments, shares especially, do fluctuate in value on a daily basis and are heavily reported on by the media – especially when there is a downturn. This means that in order to be successful as an investor, it is important to have patience, resilience and confidence in the decisions you have made. Otherwise, you will be selling your investments with every news cycle, and never giving your money the opportunity and time it needs to grow.

Fear not, however, as there are things you can do to improve your resilience and make it easier for you to stay the course and play the long game:

#1 Don’t invest money you will need

If you have money set aside or ear marked for a special occasion that’s coming up in the next few years (whether that’s a house deposit, a holiday or a wedding!), you will sleep much better at night if you keep this money aside and in a more stable investment than the share market (such as a term deposit, high interest savings account or your offset account if you have a mortgage).

#2 Have emergency savings

Successfully investing means being in control of deciding the best time to sell your investment and withdraw your funds. This means keeping emergency savings aside so that if you need money quickly, you aren’t forced into selling an investment at the wrong time.

#3 Review your Income Protection

Income Protection is another part of your emergency back-up plan. It will mean that if you are off work for an extended period due to medical reasons, you aren’t forced to sell your investments in order to pay the bills.

#4 Don’t take advice from the news

And last but not least – remember that the news cycle is all about attention grabbing headlines. It only paints part of the picture and is not the right source of information when it comes to making investment decisions.

While it is tempting to wait until a later time to get started with investing, the power of compounding means that there is no better time than the present to get started. The longer your money has to grow, the less of your own money you will need to set aside. To get started, just click here to book an obligation free consultation, and get all your investing questions answered.

Our books are open and we are available to work with you wherever you are located Australia wide.

What you need to know

This information is provided and produced by Serendipity Wealth Advisors. The advice provided is general advice only as, in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product.