Investment Magic: The Power of Compound Growth

Compound growth is one of the most powerful financial forces in the world, and it’s especially important when it comes to investing.

Essentially, compound growth means that you generate returns on both your original investment as well as on any previous returns. That second part is extremely important.

Imagine you have a choice between one of two gifts:

• €1,000,000 deposited into your bank account today, with 5% boost applied daily for 30 days – that’s a €50,000 top-up every morning.
• €0.01 deposited into your bank account today and then doubled every day for 30 days – so on day two you’d have €0.02, and then €0.04 the next day, and so on.

It’s tough to turn down a million Euros with €50,000 a day on top. At the end of the 30 days, choosing €1m will give you a grand total of €3,500,000 in the bank. Not bad.

Had you chosen that doubling €0.01, you’d be looking at a final figure of €5,368,709.12 – nearly a full €2,000,000 more than the €1m and daily top-ups.

There is a formula to calculate compound growth: P(1+r/n)^(nt) where P is the starting amount, r is annual growth rate, n is interest frequency, and t is the number of years the investment is held.

But that’s pretty convoluted and a bit too much like hard work, so let’s just work with the Rule of 72.

The Rule of 72 basically tells you roughly how long it would take to double your money. Take the number 72 and divide it by the estimated growth rate – that’s how long doubling your money takes.

So at 6% interest, your money will double in 12 years (72/6 = 12). Easy.

Of course, the nature of investments means that you can’t predict annual growth. Even if you do get a 6% average growth rate over 12 years, it’s not going to be smooth and linear; there could be some 20% years and some -15% years, all averaging out to 6% annually.

That’s why it’s so important to remember that investing is a long-term game of patience. It’s not a get-rich-quick scheme – when done properly and with a little luck, it’s a “get a little richer slowly scheme”.

Let’s compare two investors: Early Eddie and Late Larry. Both of them decide to invest €5,000 a year at 7% annual returns, and both of them want to withdraw their cash at age 65.

The difference? Eddie starts at 25 and invests for 10 years before leaving his cash to sit and grow. Larry starts at 35 but invests for 30 years.

Here’s how it works out:

One consideration with compound growth is how often growth or interest is applied.

Is the return annual (once a year), monthly (12 times a year), or daily (365 times a year)? 

The more often interest is added, the faster money grows. Imagine you invest €10,000 at 5% return for 10 years. Here’s what you have in three different scenarios:

• Compounded annually: €16,288
• Compounded monthly: €16,470
• Compounded daily: €16,532

It’s not a gigantic difference over 10 years, but over a longer investment daily compounding can result in thousands of Euro extra.

Dollar-cost averaging (or Euro-cost averaging on this side of the Atlantic) is a fancy-sounding term for a pretty straightforward investment strategy:

• Invest a small amount of money at regular intervals: you can invest as little as €100 a month with Smart Invest.
• Ignore the ups and downs of the market: don’t think about buying low and selling high.
• Let compound interest do the heavy lifting for you: remember, given enough time it’s magic!

One of the key reasons that we should be investing in Ireland is to stop “saving ourselves poorer.”

Many people keep their extra money in the bank, credit union, or some other low-interest account that generates little to no return. 

The issue with this is that while the money may be safe from the risks of a falling investment market, it is not safe from inflation.

Inflation refers to the increase in costs of goods and services over time – the recent cost-of-living crisis has thrown this into focus for many people. But even a more “normal” rate of inflation will decrease the value of your savings by a couple of percent each year.

We’ve discussed how compound growth is an incredibly powerful tool for growing money – well, inflation is the polar opposite. It’s compound anti-growth, and it can really whittle away your cash. Investments can be used to battle or potentially even outpace inflation, reducing or even negating the impact of inflation on your money.

We’ve established already that the biggest ally of compound growth is time. Consistent investments, patience, and knowing just how long the long-term is will be your biggest assets.

Now let’s explore a few more strategies:

• Finding your best investment.
• Mastering consistency.
• Avoiding major mistakes.

We have some other guides regarding choosing the best fund for you and finding your risk tolerance, but it’s worth considering how you might want to invest to maximise compound growth:

• Investment funds: these are a good balance of potential long-term growth at relatively higher returns. You can choose the level of risk and reward with which you are comfortable and have your investment managed by experts.
• Bonds: these are a lower-risk investment, especially when diversified (i.e. invested across different bonds and not having all your eggs in one basket). The downside is that the ceiling for potential returns can often by lower.
• Pension: many people don’t think of a pension as being an investment, but that’s exactly what it is. With the income tax relief on offer to eligible workers in Ireland, this could be your most fiscally sound investment choice.

One thing to note is that you should probably have your financial ducks in a row before you think about investing, especially if you want to invest more than the bare minimum. Make sure you’re free from high-interest debt and have an emergency fund built before you start your investment journey.