The Power of Compounding Over Time

Written by Communications at MASECO

“The first rule of compounding: Never interrupt it unnecessarily.”

Charlie Munger

In Indian folklore, a minister and wiseman called Sessa, apparently invented chess for his King, and in return asked for payment in grains of wheat: one grain on the first square, two on the second and doubling each square thereafter. The King laughed at him, for asking for such a small prize, obviously not realising that on the 64^th square it would be 2⁶³ (i.e. two to the power of 63, or 9,223,372,036,854,780,000) grains of wheat! It was Sessa who got the last laugh.

Figure 1: Doubling grains of wheat on each square of a chess board

Source: Albion Strategic Consulting

It has been estimated that this represents around 200 times the global wheat harvest today! Obviously, investing is unlikely to double your money every year, except in very extreme cases, usually being a recovery after a very large market fall. We have to content ourselves with much lower mid to low single digits returns on average after inflation when we invest. Yet when investing, small returns – and differences in returns – can grow into large differences in the value of your wealth. On the upside these might be positive returns from an investment portfolio. On the downside, these may be from costs that you incur or from inflation.

There is a nifty rule called the ‘Rule of 72’ that you can use to see how quickly you will double your money based on the returns that you achieve, or alternatively how quickly the value of money will be halved by inflation. All you need to do is divide 72 by the rate of return, or inflation. So, a return of 3% will double your money in 24 years (72/3=24).

Figure 2: The Rule of 72 – time to double your spending power using after-inflation returns

 

Source: Albion Strategic Consulting

Having the patience and fortitude to remain invested in a sound solution enables investors to benefit from the immense benefits compounding can bring.

Important notes

This is a purely educational document to discuss some general investment related issues. It does not in any way constitute investment advice or arranging investments. It is for information purposes only; any information contained within them is the opinion of the authors, which can change without notice. Past financial performance is no guarantee of future results.

Products referred to in this document

Where specific products are referred to in this document, it is solely to provide educational insight into the topic being discussed. Any analysis undertaken does not represent due diligence on or recommendation of any product under any circumstances and should not be construed as such.

The Legal Stuff

This document is intended for the recipient only.  It may not be copied, forwarded or otherwise distributed, in whole or in part, to any other party.

•   Nothing in this document constitutes investment, tax or any other type of advice and should not be construed as such.
• The views expressed in this article do not necessarily reflect the views of MASECO as a whole or any part thereof.
• This document is provided for information purposes only and is not intended to be relied upon as a forecast, research or investment advice.
• This document does not constitute a recommendation, offer or solicitation to buy or sell any products or to adopt an investment strategy.

Risk Warnings:

• All investments involve risk and may lose value.  The value of your investment can go down depending upon market conditions and you may not get back the original amount invested.
• Your capital is always at risk.
• Fluctuation in currency exchange rates may cause the value of an investment and/or a portfolio to go up or down.
• Information about potential tax benefits is based on our understanding of current tax law and practice and may be subject to change.  The levels and bases of, and reliefs from, taxation is subject to change.

MASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is established as a limited liability partnership under the laws of England and Wales (Companies House No. OC337650) and has its registered office at The Kodak Building, 11 Keeley Street, London, WC2B 4BA.

MASECO LLP is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the UK and is registered with the US Securities and Exchange Commission as a Registered Investment Advisor.