Why do the rich just seem to get richer? It’s a fact that money makes money and a key reason for this is due to compound interest.
It may sound like financial jargon but the way it works is simple. When you set up a savings plan, after a set amount of time you usually get a small amount of money added in the form of interest. This means you then have a bit more money than you started with. That slightly larger amount then attracts further interest, which is a larger sum than the first amount because your savings are more than you started with. The longer you keep your savings, the more the pot grows and the larger the amounts of interest you build up.
For example, if you earn the average UK salary of £27,271 and were able to save £227.26 every month (10% of your earnings) somewhere that paid you 7% interest a year, the compound interest would mean that in 10 years you’d have an amazing £39,564!
At the same interest rate and saving the same £227.26 a month, after 20 years you would have £119,076, rising to £278,867 after 30 years and, after 40 years it would be worth £599,995.
The key is in how much interest your savings are likely to attract and for most British savers, it’s where they put their savings that’s the problem. Recent research among people planning to save money over the coming year highlighted that seven out of 10 will put their money in a bank.
These savers will never be rich, for two key reasons.
- Banks pay very small amounts of interest.
- The amount of interest most banks pay is below the level of inflation and the cost of living, which means your savings are actually worth less in real terms than the amount you first saved.
Savers putting £227.26 every month into a bank account paying 1% interest would have just £134,170 after 40 years – £465,825 LESS than if they had been getting 7% interest!
The good news is that if you’re able to put some money into savings you could beat the lowly bank interest rates by using a stocks and shares ISA. This offers the ability to earn significantly higher levels of compound interest, depending on how the fund performs over the years and has the added benefit that the money you earn is tax free.
Stocks and shares tend to rise and fall in value depending on individual company performance and what’s happening in the world. This is one reason why people chose to save in ‘fund portfolios’’, a blend of different types of stocks and shares investments that mean risks are spread. Saving through stocks and shares is ideal if you’re planning to build your savings for three years or more.
There are options for different types of stocks and shares ISAs, depending on what your goals are for the savings and how much time you want to keep the money there. Using an online financial advice tool is a great way to find the right one.
Although you won’t have to speak to a financial adviser directly, your decision will be safeguarded by the fact it’s a product offered by an independent financial advice firm that is regulated by the Financial Conduct Authority (FCA). Some online companies offering access to this type of saving don’t offer you any protection that the product you choose is right for your circumstances.