Why invest to build wealth
Everything school didn’t teach you about compound interest
“When is the best time to start investing?” This a question we get all the time.
Our answer: as soon as you can*.
Of course, we may be a little biased, given Verve Money is an investing app… so we’ve decided to break down the logic here.
You’ve probably heard that a good way to grow your financial wealth is through investing. But when is the best time to start investing? You may have even heard of ‘compound interest’, but if you’re not sure what it means, and why investing your money is important, don’t worry — we’re going to break it down; because, hey, we weren’t taught this stuff at school….
How does compounding interest work?
Due to the power of ‘compounding’, investing a dollar today is worth more than investing a dollar tomorrow. A US investment platform for women, has even estimated that every single day you wait to invest could cost you about $100 in later years, that’s like giving yourself a pay cut of nearly $3,000 a month!
It might sound crazy, so we’ll break it down…
Imagine that you are able to save a little over $80 a month, so by the end of the year you have saved $1000, which you decide to invest for the next 5 years. Each year that money earns a 7% return (of course in real life you will have some better years and some worse years, but let’s imagine, for this example, it’s a 7% return every year).
At the end of the first year, you will have made 7% of $1000. That’s a return of $70.00:
Year 0 (when you start): $1000.00
Year 1: $1000.00 + $70.00 = $1070.00
Now, if you leave all of that money invested, in year two you will start with $1070, and make 7% of $1070:
Year 2: $1070.00 + ($1070.00 x 7%) = $1144.90
In Year 2, you have made $74.90, because you are also making a 7% return on the $70 in interest you made the year before, this is what is known as ‘compound interest’. Let’s see how this would progress over the next three years:
Year 3: $1144.90 + ($1144.90 x 7%) = $1,225.04
Year 4: $1225.04 + ($1225.04 x 7%) = $1,310.79
Year 5: $1,310.79 + ($1,310.79 x 7%) = $1,402.54
Total returns after 5 years: $402.54
That’s the magic of compound interest.
And while earning $403 in interest over five years may not seem like much… imagine if you were investing an additional $1,000 each year for five years. Or think about your superannuation and the tens, if not hundreds of thousands of dollars that many of us will invest into super over 40+ years of our working lives.
Timing to investing is key: two women, two investment outcomes
When is the best time to start investing? Below we’ve created an example of two fictitious women who have decided to invest. Mel has decided to save and invest $100 a month and starts at age 30, whereas Vanita doesn’t start investing until age 40, but then decides to catch up and invest $200 a month. Check out how much they invest, and how much they earn from their investments assuming both receive a constant return of 7% p.a.
The lesson: get going early, but better late than never!
The Australian Government MoneySmart website has a great compound interest calculator, you can experiment with different investment values and see how much you could earn.
Investment returns come with risk, here’s how to weigh it up
What you’re probably thinking right now is sure, but what about the global financial crisis? Um.. what happens if I invest in shares and the market drops? Well, good question!
Every investment you make comes with risk, when it comes to shares, typically shares with higher potential returns also come with higher risk. Now, let’s have a look at what that means in reality by comparing two types of investments over the past few decades.
Take a look at the below graph of the share market over the past 30 years, you’ll see that if you had invested in ‘cash assets’, which are typically the safest kind of asset (note: this is not the same as having cash in your bank), then you basically would have more-or-less made a profit each year and an average profit of 4.3% p.a. If you had invested $10,000 in July 1992, by June 2022 you would have around $35,758. That’s not bad.
By contrast, if you had invested your $10,000 in the companies on the Australian Stock Exchange (ASX), you would have made money most years but you would have also lost money in some years, including suffering losses in the Global Financial Crisis in 2008/09. Yet, despite the occasional downs in the market, your gains would have been much higher and you would now have an estimated $131,413.
Stocks are typically the riskiest part of an investment portfolio, but over the past 30 year period the ASX has gone up by an average of around 9% p.a – check out the graph above.
Know your investing goals and make a smart decision
When it comes to working out the level of risk you are willing to take, and how much you want to invest in shares, you will need to have a think about: what your saving money for; when you will want to access that money; and what would happen if you lost some of the money in the short term.
When is the best time to start investing? Based on the historical long-term growth of the share market, investing in shares has proven to be more useful than simply saving if you want to achieve your money goals and build financial wealth. As a next step, check out the MoneySmart website to assess your own level of risk and what kind of investment is most likely to suit your savings goals.
*Of course there is an asterisk to this answer: before you make any decision to invest money, it’s important that you consider your own financial situation. As an example, if you have high cost debt (i.e. credit card debt), it’s generally better to pay that off than to invest – remember compound interest will work against you if you are in debt! Check out the Money Smart website or speak to a Financial Adviser if you want personal guidance to determine if you are ready to invest.
This article is published by Verve Money Pty Ltd (ABN 71 653 669 366, AFS Representative No. 001294184), a Corporate Authorised Representative of True Oak Investments Ltd (ABN 81 002 558 956; AFSL 238184), as the Manager of Verve Money. A friendly reminder that all the financial information contained in this article is general in nature and does not take into account your personal financial objectives, situation or needs. It’s important to do your own research and consider getting in touch with a professional adviser to access specific information tailored to your unique situation.
You should read the Product Disclosure Statement, Investment Guide, Target Market Determination and Financial Services Guide before making a decision to acquire, hold, or continue to hold, an interest in the Verve Money Fund. Visit www.vervemoney.com.au/documents to view these documents.
Interests in the Verve Money Fund (ARSN 662 622 899) are issued by Melbourne Securities Corporation Limited (ACN 160 326 545, AFSL 428289). When considering financial returns, return of capital is not guaranteed and past performance is not indicative of future performance.