The Extraordinary Power of Compound Growth

Simple, repeatable actions completed over a long period of time = extraordinary results. 

Compounding growth is the most powerful tool at your disposal.

It is also the most underutilised.

Today, I am going to show you why you must take advantage of compounding growth and how to do so.

The best time to plant a tree was thirty years ago; the second-best time is today.

Humans struggle to grasp exponential growth.

Because humans think linearly, we struggle to comprehend exponential growth. We often underestimate the impact of small actions repeated over a long period of time.

Let’s use an example to prove the point.

If you folded a piece of paper 42 times, how thick would it be?

The answer?

That folded piece of paper would reach the moon. It would be 439,800km thick!

Despite checking the maths, and ‘Googling’ it 3 times, I still can’t fully believe this is true.

It is for this reason that so few people experience the full benefits of compounding growth. It is so difficult to comprehend that many people disregard it.

Please don’t do that.

Getting to grips with compound growth.

To benefit from compound growth, you first need to fully understand the concept.

Something compounds if it grows at a constant, or increasing, growth rate.

Let’s dive into that statement.

First, what isn’t compound growth?

If you put £50 into a jar every year you will not experience compounding growth. Each year, your growth rate decreases:

• In year 2 the balance is £50, and it grows by £50. That is 100% growth.

• In year 3, the balance is £100, and it grows by £50. That is 50% growth.

• In year 4, growth is 33%. And so on.

However, if you start with £500 in a savings account that grows at 10% per year, you will experiencecompounding growth. Your growth rate, 10%, remains constant.

• Year 1 growth is 10% of £500. £50.

• Year 2 growth is 10% of £550. £55.

• Year 3, 10% of £605. £60.50.

Building wealth takes time.

To realise the full wealth-building benefits of compounding growth you need a long time horizon.

When I worked at Barclays, I constantly heard the refrain “it’s not timing the market, its time in the markets”.

Catchy, and true.

Market returns can fluctuate wildly year-on-year. If your time horizon is too short (anything less than 5 years), then your investment may not grow at a constant or increasing growth rate.

When expanding the time horizon and zooming out, the general direction of the market is up.

Despite experiencing yearly declines of 35%, 33% and 13%, over the last 22 years, the S&P500 has an average yearly growth rate of 11%.

Money motivation.

Let’s use that 11% average growth rate to illustrate the power of compounding growth.

On its own, 11% isn’t particularly exciting.

Nice, but not exciting 

However, lets add a long time horizon to it. The results are mind boggling.

The animation below illustrates a hypothetical £500k investment in the S&P500 which is then left to grow for the next 50 years.

That £500k investment would be worth a whopping £83.1m!

Of course, we don’t need wealth anywhere near that large.

We simply want to take advantage of compounding growth to reach financial freedom.

So let me show you what would happen with the following circumstances:

• Bob starts work at 21.

• He invests an average of £10k per year for the first 10 years.

• He then invests an average of £30k per year for following 10 years.

• His investments grow at an average of 11% per year.

• After 20 years of work, he stops investing and instead withdraws £50k per year.

• Bob dies at the ripe old age of 91.

What?!

Bob has still left his family with an insanely large pile of cash.

He retired at 41. He spent £50k of his portfolio every year.

But, the power of compounding growth has more than made up for his "poor work ethic" and liberal spending.

When he retired, he had a portfolio of £1.03m. He withdrew £50k per year but in our hypothetical situation his portfolio was growing by 11%.

As his portfolio grew, his withdrawal rate decreased (see appendix for explanation). As a result, his growth rate was constantly increasing providing the conditions needed for compound growth. 

In Summary

Bill Gates once said, “Most people overestimate what they can do in one year and underestimate what they can do in ten years.”.

The same is true of investments.

I hope this inspires you to create the conditions needed in your life to experience compounding growth.

Remember, patience and consistency can deliver extraordinary results.

Appendix

Bob’s Portfolio is worth £1.03m when he starts withdrawing £50k per year.

This is a withdrawal rate of 4.84%.

The market growth rate is 11%.

Therefore, his effective growth rate is 11%-4.84%=6.16%.

After the first year his portfolio is now worth £1.09m.

His withdrawal rate is now 4.56%. (£50,000/£1,090,000)

The market growth rate has remained steady at 11%.

So his effective growth rate is 6.44%.

His effective growth rate is increasing each year.