Compounding – “The Eighth Wonder of the World”. A. Einstein.

Compounding – “The Eighth Wonder of the World”. A. Einstein.

“Someone is sitting in the shade today because someone planted a tree a long time ago” – Warren Buffett

Arguably the easiest way to get wealth actually takes no skill or effort. Just sit back and let time do its thing.

The book The Richest Man in Babylon explains this by your gold coins creating children and grandchildren, all working for you, even while you sleep.

This is the only financial concept I remember learning at school.

Simply put, if you invest £100 for a year, at 10% interest, after a year you have £110. If you spend the £10 gain, you are back to £100 and £10/year growth.

If however you leave the £10 there (reinvesting your dividends), after a year you have £110, after 2 years £121. The extra £1 in the example may seem pretty insignificant, however that £1 is earning you money every year going forward. As are the £1s generated by that money.

Think of it a snowball. It starts off small, gradually getting bigger, but as it rolls on the rate of increase grows exponentially.

This is why we really need to start investing as early as possible. The best time to start was 20 years ago, but if like me you’ve missed that boat, start today!


Of course compounding works in both directions. Interest on your bank savings compounds annually.   Credit card debt compounds DAILY, so the headline rate of 19% or so is considerably less than you actually pay. Let alone the fact (hidden way down in the small print) that the interest is added to the oldest purchase first, so the ‘interest-free’ period isn’t the bonus you may think it is.

The following example shows the difference in simple (dividends not re-invested) and compound returns, given an annual 8% return. Initially there’s little diffence, but over time, with the snowball rolling on, the chart speaks for itself. So I’ll shut up.

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