In Albert Einstein’s own words, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” And he’s right…So just from that you can see that compounding is actually a pretty big deal. 

Compounding is also known as compound interest or compound growth. It occurs when interest is added to an existing initial amount, and then that new amount accumulates and earns interest. Compound growth is essentially interest on interest. If you think back to your maths class at school when you were plotting exponential growth curves on graphs – that was compound interest. 

Compounding happens naturally in savings accounts. Sometimes you’ll see the amount in your account grow even when you haven’t added any money. That’s compound interest in action. 

A great example of the power of compounding is the choice between an instant cash payment of 1 million pounds or a penny that magically doubles every day for 30 days. Which one gives you the most money in the end? Which would you choose?

Most people would immediately take the 1 million pounds. But if you do the calculations, that one penny would actually be worth over 5 million pounds. Mind-blowing, right?

What does compound interest have to do with investing?

Compounding is also important in investing as the money you get from your assets gets added to your initial amount and is reinvested to generate extra profit over time. This increases the value of the assets you hold. 

The effects of compounding can seem minimal in the beginning stages, but this really picks up and increases over time. The longer you leave your money to compound, the better. 

Someone starting their investing journey in their early 20s can invest less per month and end up with more money overall than someone starting their investing journey in their 30s and putting more money per month into their investments. 

So when it comes to investing, and pensions, even though it might seem counterintuitive, it’s better to start earlier (even if you’re only investing a little) than to wait 5 or 10 years (when you might have more to invest). 

The earlier you start investing, the longer you can get that magic to work for you!