In an earlier article, I wrote with some confidence that one day I will be a millionaire. Am I arrogant or deluded? Probably a bit of both, but more importantly, I understand the importance of exponential returns. Exponential returns, compounding or whatever you want to call it is basically a description of how money grows more money at an ever-increasing pace.
Everyone hates maths so I’ll keep this short and simple. Boring stuff like inflation and tax have been ignored to make the point easier to understand.
Say you have £100. You save or invest this and get a return of 7% so at the end of the year, you have £107. OK, that’s not particularly exciting. Some idiot on those internets told you it’s a good idea to save your money because of this compounding stuff, so you decide to leave this money where it is. Another year has passed and your £107 has earned another £7.49. At this point you have £114.49. Two years of your life have passed and you’ve noticed that you’ve only earnt a total of £14.49. It’s easy to feel cheated. You could have spent that money on crack or knives or whatever it is that kids spend their money on these days but instead you invested it and got almost nowhere. Before you decide to get off your face on White Lightning and stab a stranger in the park, you should take note of one important fact:
It’s important to invest as early as possible because it takes a while for you to really see the benefits.
Don’t freak out but I’m going to show you a graph now. It simply shows how £100 would grow over a number of years if it were able to grow at 7% per year.
OK, one more graph. This one shows what happens if you invest £1000 a year, again, at a rate of 7%.
Saving £1000 shouldn’t be too difficult as this is little more than £80 a month. If you can’t afford to save this amount, you need to seriously look at your spending habits and/or earning potential. Anyway, if you save this amount every year, after 10 years you’d have £16K, after 20 years, you’d have £45K and after 30 years you’d have cleared the £100K mark. This is what happens if you play a gentle investment game but what happens when you’re more aggressive? Well, let’s be a little more conservative and say that I aim to make 6% a year from investments. If I invest £10K a year in tax-free investments (and I do) then I can expect to be a millionaire by the time I’m 60. Now my challenge is to do this by the time I’m 35 by improving my ability to generate the monies!