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How the rich get richer

How do some people achieve their desired level of wealth and others simply don’t? There are many different factors and variables to answer such a question but it nearly always doesn’t happen just by accident. One way in which it is possible to grow your money is through the concept of ‘compound interest'. This is the idea of your money earning you more money over time.

In this blog we will take a look at ‘compound interest' and an example of how it works in principle. Albert Einstein called it ‘the eighth wonder of the world’. Let’s see why he spoke so highly of compounding.

It’s always clearer to explain an idea using an example! Let’s look at how this could work.

If you invested £100,000 and were able to achieve a 5% annual return on investments each year, whilst reinvesting the initial 5%, your original investment of £100,000 would now £105,000 after year 1. If you can continue to earn a 5% return on your investment, the second year return will be 5% on top of £105,000, and so on year on year. The gains can really add up after many years of reinvesting and compounding.

The hardest part in our example may be to find investments that return 5% or more, but that is where a financial adviser can help to find investments that are suited to your circumstances and investments that match your appetite for risk. This formula does not take into account inflation and the future value of money, so it’s important to speak to a financial adviser who understands the practicalities of finance and the management of money; someone who works in this area daily.

Here is a much more detailed explanation of the concept of compounding interest from Investopedia. (https://www.investopedia.com/terms/c/compoundinterest.asp )

After many years of reinvesting and compounding, the problem you will have is withdrawing some, or all, of your money, as tax may be due. Again, this is where a financial adviser can help you and your investments to be tax-efficient.

The secret to ‘compound interest’ is to start as young as possible, as it can take many years for the compounding of the growth to take effect. Many younger generations might not think to invest, let alone take any financial advice. Ironically, time is the greatest factor in the idea of ‘compound interest’. It is necessary to practice such investing early to experience the wonders of how ‘compound interest’ works.

If you would like to discuss any aspect of personal finance please get in touch with us on 01302 244 977.

 

This information is intended to provide a general review of certain topics and its purpose is to inform but not to recommend or support any specific investment or course of action. The tips may not apply, or be suitable, to everyone and you should contact us for advice if you are unsure whether this is the case.

Ethos Financial Solutions Ltd are authorised and regulated by the Financial Conduct Authority.

Publish date: 30th May 2018

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