Investing can be an intimidating prospect for many but it’s one of the most powerful tools for building wealth and achieving financial security.
Because investing is often misunderstood - with very little education in school about it - many people delay investing. This is often due to misconceptions, for example you might believe that you need a large sum to get started or think that you have plenty of time to get round to it one day.
In reality, the sooner you start investing, the greater the potential rewards. Thanks to the power of compounding, time in the market, and the ability to take advantage of long-term growth, investing early can make a significant difference to your financial future.
Read on to find out why investing as early as possible has such a big impact on your wealth.
1. The power of compounding
If you’ve heard of compounding, it’s possibly in relation to interest. The interest charged on loans and paid by banks on your deposits is compounded. This means that interest is rolled over and charged - or paid - on top of interest.
The same applies to investing over the long term. When you invest money, your returns generate further returns, creating a snowball effect over time. The longer you leave your money invested, the more potential for exponential growth.
Since 1957, the S&P 500 index in the US has returned, on average, 10% per year (including dividends and excluding inflation). The past is no guarantee of future performance, but let’s assume an example with an annual return of 7%.
If Investor A starts investing £200 per month at age 25 and achieves an average annual return of 7%, they will have around £362,300 by the time they turn 60.
If Investor B starts the same investment at 35, they will only accumulate around £163,000 by age 60. That’s more than double the value but with only 40% more in contributions. A ten-year delay can cost hundreds of thousands of pounds over the long term.
2. The cost of delaying
Put another way, delaying can be costly. The later you start investing, the more money you need to contribute to achieve the same goal.
Consider the following example. To reach an investment portfolio value of £250,000 by age 60 assuming a 7% annual return:
- If you start at 20, you'd need to invest £95 per month
- If you start at 30, you'd need to invest £204 per month
- If you start at 40, you'd need to invest £477 per month
Delaying means you must work harder or longer, and contribute more, to catch up to reach the same financial goals compared to someone who started investing earlier.
3. The longer the time horizon, the lower the risk
Investing early allows you to take a long-term approach which helps smooth out any short-term market fluctuations.
Stock markets can be volatile, for example during the Covid pandemic, and can fall as well as rise. But history has shown that over the long term - decades - equities tend to provide solid returns.
Starting to invest sooner means you have more time on your side so you can ride out any bumps along the way.
4. Small amounts can grow significantly over time
As mentioned above, a common misconception that many people have when it comes to investing is that you need a large lump sum to start with.
That’s not true today and, thanks to compound growth, small and consistent investments can grow into a substantial investment pot over time.
In the UK most adults have access to a Stocks and Shares ISA which even allows for investment growth free from income and capital gains taxes.
This means you can make long term compound returns without any reduction due to taxes.
By investing just £50 per month into a stocks and shares ISA, you could see significant growth over decades. Investment apps such as Beanstalk allow for automated investing through direct debits - making the process even easier and helping to ensure you stay consistent.
5. Beating inflation
Since the Financial Crisis in 2008-9, interest rates dropped to close to zero in most Western countries until the last couple of years where they began to rise again.
During this near-zero rate environment, the return you could earn often did not beat the rate of inflation. If your savings are earning interest at a rate lower than the rate of inflation, your purchasing power reduces over time.
Interest rates on savings have improved since the Bank of England began increasing the base rate from December 2021. But over the long term, the returns from investing in the stock market have been shown to beat the return you can typically get from cash savings.
Investing in assets like equities, for example through simple Exchange Traded Funds (ETFs), provides the potential for higher returns than cash savings. This helps protect your wealth against inflation and to maintain your future spending power.
6. Developing good financial habits early
Investing from a young age builds essential financial habits, such as budgeting, consistency and patience.
Many successful investors start early and develop good habits over time, including learning from their experiences and avoiding costly mistakes like panic selling or chasing quick profits.
Over time, seeing your investments grow reinforces these positive habits. Many people’s income tends to rise as they get older and they can often fall into the trap of ‘lifestyle creep’, where your expenses rise in-line with your income.
But, if you started investing at an early age, you’re less likely to fall into that trap and can instead simply increase your monthly investment contributions as your income grows.
Final thoughts
The biggest advantage in investing is time. The sooner you start, the more you benefit from compound growth, consistency and good financial habits. Even if you start small, the habit of investing early can help to set you on the path to long-term financial success.
You don’t need a large lump sum to get started and you don’t need to be an investment professional - simply making monthly contributions into tracker funds is a simple way of getting started.
About the author
Alex King is a Chartered Accountant and founder of personal finance platform Generation Money. You can read Alex’s independent Beanstalk app review here.