Compounding

[longviewmind]

I keep hearing about the power of compounding. But does anyone have experiences of really seeing it work?

Look online for a compound interest calculator, stick some figures in for savings over a prolonged period, and it will demonstrate exactly for you the power of Compounding.

Pensions. The contribution you made in your 20s has turned into loads more by the time that you retire thanks to compound interest.

I was thinking more how it feels when it does [work]. TBH that's where I'm at. Sorry - should have been clearer. We've been squirreling away for 20 years and it feels like quite suddenly those investments have taken off. And it feels.....weird. Like we don't deserve it, or almost like it's magic. I've always got the maths - it's just weird to see it unfolding.

If you want to come back down to earth a bit , run the compounding effect of inflation over the same period - it’s the difference which matters in real terms, alas!

I understand compound interest - receiving interest on your interest . So I understand it in relation to cash savings.

but I’ve never understood it in investment terms. Becuase investment values fluctuate and can go down.

so how does compounding work in investing, please?

Yes, I know this feeling. Now 60 and can't work out where it has all come from. Truth is I saved into my pension from 24, put bits into ISA when I could, we nibbled at the mortgage, were eventually lucky with house values (after negative equity for most of the nineties) and it gradually grew then got to a critical mass.
I haven't compared with compound inflation as that would likely be depressing

If you invest in equities (shares), the same effect as compounding can work in one of two ways.

The firm can reinvest profits back in the business, to grow the value of the business. What you'd see in your stockbroking account would be the value of those shares rising.

A better comparison would be the process of dividend reinvestment. A company can return profits to its shareholders in the form of dividends. You then use those dividends to buy more shares. Even if the value of the shares doesn't move, you'd have more shares - which would then mean a bigger dividend payment next time. You reinvest that by buying more shares... and so on.

With investment funds, you can often choose income versions (which pay dividend income straight to you) or accumulation versions (where the fund manager reinvests the income within the fund before it ever gets to you) of the same fund.

@InveterateWineDrinkerthank you.

But even then that’s only assuming that the shares go up in value or stay the same? So it’s not a guaranteed compounding effect like in cash, it’s jus a possibility?

@tothewindow25

Correct, nothing is ever guaranteed, but in return for higher risks you'd expect higher returns. There are any number of stocks listed on the London Stock Exchange which pay yields in the 7-10% range - a lot more than you'd get in cash savings.

@InveterateWineDrinkerInteresting, thank you

Yes, it is the best thing you can do as your interest accumulates over time and you earn interest on the interest so the returns mount up considerably over the years.

'Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn't, pays it.' Albert Einstein.

The quote was one of the first things I discovered when trying to teach myself about saving and investing in early adulthood (pre-internet times). It's a quote that's kept me on a secure financial track.