Everything You Need To Know
- Compounding is the maths that’s actually useful. Think of compounding as a snowball rolling downhill. As it does so, it gathers more and more snow and gets bigger and bigger.
- Compound interest on cash. If you leave the interest in the bank it increases your balance, and when interest is next calculated is is worked out on the new higher amount – more interest. Continue this and that’s the snowball.
- Compound interest on debt. If you owe money and don’t pay it off before interest is due, then this can quickly become a problem.
- Compounding on real assets. Shares produce a dividend income and also their value rises and falls. If you reinvest the dividend income by buying more shares with it, and then the share prices also increase. Some real assets don’t produce an income – they can never grow through compounding, only their price goes up and down. Gold is a good example, or any other commodities.
Compounding really is like magic. Nobody becomes wealthy by just leaving money in the bank and getting the interest.
Everything You Need To Do
- Don’t hold too much cash.
- Don’t get in the way of compounding. We take money out of investments without VERY good reason. This is what the emergency fund is for – so as not to have to take invested money out while it is compounding for our benefit.
- Invest intentionally. This means that it isn’t good enough to just stash your money into your workplace pension into the default fund and at the default level of contribution. Better than nothing but far better to be intentional, learn about investments and maximise opportunities.
- Watch for costs. Pensions and ISAs are the best for tax, but also VCTS and EISs for those who are risk-happy and have already maxed out their pensions and ISAs. Pensions even add extra money in from HMRC and possibly your employer, so compounding is working on money that isn’t even yours. Pensions are long-term too, usually, which is one of the ingredients for effective compounding.
