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In 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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