What would happen if you stopped investing today?
Long term investments and compounding returns are a powerful pair.
You may have come across memes doing the rounds of social media about one of the early co-founders of Apple Inc, who sold his 10 percent stake in the company for $800 in 1976. Just recently, Apple hit the $1 trillion mark for market capitalisation. It highlights how compounding returns are so valuable for investors.
To be fair, companies like Apple have benefitted from tech innovations that have helped to boost returns over time. But what would happen to your wealth if you stopped saving and investing today?
The answer hinges on where your investments lie. As a guide, SuperRatings found that $100,000 invested in a balanced-style superannuation account back in 2008 would be worth around $185,412 today. If your super was invested in Australian shares it could have grown to $196,190, or $211,000 if you opted for international shares. These figures, which assume no annual contributions, highlight the power of compounding returns.
Super offers a great example of compounding because it’s a very long term investment. We can’t usually dip into the funds until much later in life. And along the way, investment returns are reinvested back into our accounts. It’s the ideal combination for the value of compounding to really kick in.
The beauty of compounding is that even small investments can become large sums over time. Growth assets like quality shares and property are good for compounding because they can rise in value as time goes by, and often provide tax advantages (like franking credits on share dividends) that can generate higher after-tax returns over time. This matters because to maintain your standard of living once you finish work, you need your income to grow with inflation. Growth assets will do this.
This underscores the need to be careful about being seduced by regular (and predictable) returns on bank deposits. They can be tempting during periods of market volatility or economic uncertainty. But not only are returns on cash fully taxable, the capital value of your asset won’t increase.
The catch with compounding is that it takes time for the power of ‘earning returns on your returns’ to really kick in. The earlier you start saving and investing, the better. If you can hold onto your investments for the long term, and resist the urge to cash out at the first sign of market jitters, the more likely it is you’ll experience firsthand the magic of compounding returns. The bottom line is, the early bird can wind up with the fattest worm – even if you stopped saving and investing today.
Paul Clitheroe is Chairman of InvestSMART, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.