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Third: Does a fee for investment management make that much difference?
Many people are charged fees of more than 2% on their portfolios invested in funds such as unit trusts. The headline figure of say a 1.2% or 1.5% given………..To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
Compound interest is the eighth wonder of the world. Never interrupt it unnecessarily. (Charles Munger)
One of the most valuable principles for investors to follow is to leave the power of compound interest to do its work, without interruption from withdrawal of money from the pot (even temporarily), without incurring high transaction charges and without incurring high taxes.
First: does the compounding element make that much difference?
If I offered to pay you interest on the £100,000 you hand over to me at a simple interest rate of 6% per year then, after one year I credit your account with £6,000.
After two years I credit your account with another £6,000. But, crucially with simple interest, you will not earn interest on the amounts credited to your account other than on the originally £100,000.
Thus after 30 years I would have credited you with 30 x £6,000 = £180,000. If you now ask for your original £100,000 plus the interest you will have £280,000 on which to retire. Impressive, you might think.
Now change the assumption: This time the added interest is compounded, so interest is gained on the amounts credited each year.
| Simple interest – total amount in account | Compound interest – total amount in account | |
| One year | £106,000 | £106,000 |
| Three years | £118,000 | £119,102 |
| Five years | £130,000 | £133,823 |
| Ten years | £160,000 | £179,085 |
| Fifteen years | £190,000 | £239,656 |
| Twenty years | £220,000 | £320,714 |
| Thirty years | £280,000 | £574,349 |
For the first few years the compounding effect doesn’t appear to make much difference to the amount in the account. For example, after five years there is only an extra £3,823 due to compounding.
But after 30 years the size of the pot is more than doubled to £574,349 because of the compounding effect.
Second: does a percentage point make that much difference?
You may think that achieving an extra percentage point on an investment is such a small number that it won’t make that much difference.
As the table below shows, that is true for the first few years, but with long term compounding that extra 1% per year adds up to an extra £186,877 on the original £100,000 invested.
| Compound interest at 6% – total amount in account | Compound interest at 7% – total amount in account | |
| One year | £106,000 | £107,000 |
| Three years | £119,102 | £122,504 |
| Five years | £133,823 | £140,255 |
| Ten years | £179,085 | £196,715 |
| Fifteen years | £239,656 | £275,903 |
| Twenty years | £320,714 | £386,968 |
| Thirty years | £574,349 | £761,226 |
