Do You Truly Understand The Power of Compounding? [CHART]

The Power of Compounding by SG Investor

After conversing with various individuals, I realise many do not truly understand the power of compounding. In the following example, it shows 3 different individuals who starts investing in the same fund at different points in their life. We would assume that the long term average returns of the fund is 7%.

Individual A: Invests $5,000 each year from age 25 to 60.

Individual B: Invests $5,000 each year from age 25 to 35.

Individual C: Invests $5,000 each year from age 35 to 60.

As expected, Individual A who started investing at a much earlier age of 25-years has the largest portfolio out of the three. However, one has to note the huge difference Individual A has compared to the other two for just investing 10-years earlier. Furthermore, Individual B ends up with more money than Individual C, despite the latter investing 2.5x more money than the former. This is due to Individual B investing in an earlier age and allowing that money to keep compounding over the years.

I hope that through this example, everyone would understand the concept of compounding and the importance of starting young. I have assumed a starting age of 25 (where most individuals have started working) and an end age of 65 (Singapore’s retirement age).



About the Author

SG Value Investor
I developed my passion for investment management especially equity research at a relatively young age. My investment journey began when I was 20, at a point in time where markets were still recovering from the Global Financial Crisis. My portfolio started from money I saved over the past years and through working during the holidays. I was fortunate to have a good friend with common investing mentality to began my journey towards value investing. To date, we still research and invest in companies together, discussing valuations and potential risks of a company. To date, I manage a fund with a value investing style. Positions are decided upon via a bottom-up approach or smart speculation (a term I came up with when buying a stock for quick profit due to a mismatch in prices in the market due to takeovers/selling of a subsidiary or associate). Apart from managing my own portfolio, I enjoy sharing my research with family and friends, seeking their opinions and views towards the stock. Reading Economics in London, I constantly keep up with the financial news in Singapore & Hong Kong. Despite my busy schedule, it has not stopped me from enjoying other aspects of life. I enjoy a variety of activities in whatever free time I may have – endurance running, marathons, traveling, fine dining, whiskey appreciation, fashion. Lastly, I enjoy meeting new people, discussing ideas and gaining new perspectives towards issues in the world.