Written by Andrew Fort

Last month I wrote about The Miracle of Compound Interest and how it could be genuinely life changing. I now wish to put the flesh on the bone, so to speak.

Over the last 10 years, using the Retail Price Index (RPI), inflation has averaged 3%. To keep pace with inflation £100,000 ten years ago needs to have increased to £134,390 simply to maintain the same purchasing power.

Over the same 10 year period cash, that is money deposited in a bank or building society, has averaged a return of no more than 0.5% each year. £100,000 would have increased to £105,110. If you switched your money from one “best buy” account to another year later you might have increased the return somewhat.

On the other hand, if you were prepared to invest your money in a globally diversified mixture of shares equities and bonds you could have achieved an annual return of 8%. Unlike cash, where there is a guarantee that your capital is guaranteed such an investment will fluctuate in value and you may not get back what you invested. However, if you are prepared to weather the downturns and stick to the investment, £100,000 would have grown to £215,890. This, I think you would agree, is genuinely life changing. It is all down to The Miracle of Compound Interest.

Naturally, I do not suggest that you should allocate all of your money to a fluctuating investment. Cash always has a role because it provides a safe haven for those times when stock markets fall. It is, however, a grave mistake to hold too much in cash.

Over longer periods of time The Miracle of Compound Interest has an even greater effect. Over the last 32 years inflation (RPI) has averaged 3.3%. £100,000 would need to increase to £282,620 simply to keep pace with inflation. Interestingly, over this long period of time the average return from cash has been slightly higher than RPI – £100,000 would have increased to £409,000.

The same mixture of globally diversified shares equities and bonds would have achieved an annual return of 9.5%, meaning that £100,000 would have increased to £1,824,950.

As I said, genuinely life changing for those of you prepared to take a long-term view, by creating an investment strategy and sticking with it through good times and bad.

March 2020