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The Story of Prudence & Extravaganza

October 20, 2010 at 8:53 AM

fun.gifIn previous articles, we have shown you how to get wealthy. This time, we thought we would share with you our No.1 tip: Start Early!  If you do, you can let the magic of compounding take hold and carry you towards financial freedom.

When investing, what you get back depends primarily on 4 factors:

  • When you start
  • How much you contribute
  • The rate of return you achieve
  • The length of time you are able to leave the money invested and let compounding work its magic

Most people get overly concerned about the third point – the rate of return. Whilst this is obviously important and can make a significant difference, the most important weapon in your investment armoury is available to all and is completely free – it is quite simply, time. The sooner you start, the richer you will become – simple as that.

 

Prudence

Consider the story of two 25-year-old sisters, Prudence & Extravaganza. Prudence has understood the magic of compounding and started to save £1,000 per year in 2002 and gets an average return of 9% per annum*. She invests for 10 years only and then stops. She doesn’t pay in another penny for the next 25 years but leaves her investment until age 60 in 2036 when it is worth £131,009. 

 

Extravaganza

Extravaganza has been living the high life for 10 years and now thinks she had better start putting some money away for her future. She starts savings £1,000 per year at exactly the point when Prudence stops. Extravaganza also achieves 9% per annum average return but she doesn’t stop after 10 years. She keeps investing for another full 25 years until she is 60. She has invested 150% more than Prudence over the 35 year period and what is her fund worth at the end? £84,701 - only 65% of her sister’s investment fund. 

No matter how long they keep saving, Prudence will always have more, despite the fact she only invested £10,000 – and that is purely because she started early.

 

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End of Year         Prudence             Extravaganza                    

2002                       £1,000                   £0          

2003                       £2,090                   £0          

2004                       £3,278                   £0          

2005                       £4,573                   £0          

2006                       £5,985                   £0          

2007                       £7,523                   £0          

2008                       £9,200                   £0          

2009                       £11,028                 £0          

2010                       £13,021                 £0          

2011                       £15,192                 £0          

2012                       £16,560                 £1,000  

2013                       £18,050                 £2,090  

2014                       £19,675                 £3,728  

2015                       £21,446                 £4,573  

2016                       £23,376                 £5,985  

2017                       £25,480                 £7,523  

2018                       £27,773                 £9,200  

2019                       £30,273                 £11,028

2020                       £32,997                 £13,021

2021                       £35,967                 £15,192

2022                       £39,204                 £17,560

2023                       £42,732                 £20,140

2024                       £46,578                 £22,953

2025                       £50,770                 £26,019

2026                       £55,339                 £29,361

2027                       £60,320                 £33,003

2028                       £65,749                 £36,973

2029                       £71,667                 £41,301

2030                       £78,117                 £46,018

2031                       £85,147                 £51,160

2032                       £92,810                 £56,764

2033                       £101,163              £62,873

2034                       £110,268              £69,532

2035                       £120,192              £76,790

2036                       £131,009              £84,701

* This is an example rate of return and is based on the Fidelity Special Situations Fund, which (as at 1st July 2009) had a 10 year annualised return of 9.71%.



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