Warren Buffet has often claimed the most powerful factor behind his investing success is compound interest. Einstein called it the eighth wonder of the world.
The principle behind compound investment is simple. Even at modest levels of returns, over a long enough time scale, the growth is exponential.
The reason being that every year (for example), the interest or profit made from investing is reinvested. So not only does your initial capital grow, there is growth on the previous years profits (growth). This eventually builds at ever increasing velocity, as the capital grows larger through re-investing.
One example of this, quoted from Buffet, is King Francis’ decision to commission the Mona Lisa in 1516 for $20,000. Had the King instead invested the money at a growth rate of 6% per annum instead, today it would be worth over $1 quadrillion (15 zeros).
The most important lessons to learn from this, for an investor is :
- Start early
- Reinvest profit
- Look for stable, long term, returns
A good example would be index trackers. Investment funds that track stock indices such as the UK or US stock market, have historically stable positive performance. They may not produce the huge returns associated with hedge funds, or startup companies, but they also don’t have the large drawdowns and volatility.
Compound investing over the long term is ideal for pensions, and long term saving funds.
Morningstar and Trustnet are two fund research websites, which provide a wealth of information. The latter now has a dedicated section for passive tracker funds, which can be found here www2.trustnet.com/passivefunds/