Leveraging the power of compounding over time is at the heart of investing.
“I wish I’d started investing earlier”, and “Start as soon as you can. It’s never too late”.
They’re common responses to the question we’ve asked numerous Vanguard customers: “What advice would you give to your younger self?”
But how does starting earlier actually translate in terms of total investment returns over time, and financially? In other words, is there a potential opportunity cost from sitting on the investment sidelines?
And, lastly, how does making a one-off initial investment stack up over time compared with making an initial investment and then following that up with regular monthly investments?
The cost of holding off
To humanise this calculation, it’s worth comparing two hypothetical people who turned 20 years old back in 2004.
Both had started their first full-time jobs then, however only one of them began investing from the beginning of 2004 (on the first trading day). The other only started investing 10 years ago, from the beginning of 2014.
Compounding is nothing short of a miracle. As a result, even little investments started in one’s early twenties are likely to grow into enormous sums throughout a lifetime of investing — John C. Bogle, Vanguard founder
For the purposes of this article we’ve used the investment returns based on the Australian share market’s S&P/ASX All Ordinaries Total Return Index. The index measures the returns from the 500 largest companies on the Australian Securities Exchange including the cash dividends paid, and assumes that all dividends were reinvested in order to calculate the total return.
It is not possible to invest in an index as such, however a managed fund such as an exchange traded fund (ETF) that tracks a specific market index will produce a similar return before fees and taxes are deducted.
The end balances shown below were as at 30 June 2024 based on an initial starting investment of $500.
| Investor 1 | Investor 2 |
|---|---|
| Started investing on 2 January 2004 | Started investing on 2 January 2014 |
| Balance: $2,815 | Balance: $1,142 |
Source: Vanguard
Note: Returns are after fees and before taxes, with dividends or interest payments reinvested
So, the end balances in the table above immediately show that Investor 1, who started investing in a fund tracking the S&P/ASX All Ordinaries Total Return Index in 2004 would have achieved a total return more than double that of Investor 2, who started investing 10 years later in 2014.
But how would the two investors have compared if they had once again started investing 10 years apart, but this time they had both followed a regular investing strategy on top of their initial $500 investment?
Both Investor 1 and Investor 2 committed to invest an additional $200 per month.
| Investor 1 | Investor 2 |
|---|---|
| Started investing on 2 January 2004 | Started investing on 2 January 2014 |
| Balance: $123,254 | Balance: $41,467 |
Source: Vanguard
Note: Total returns based on a $500 initial investment and $200 monthly investments. Returns are as at 30 June 2024 and after fees and before taxes, with all dividends or interest payments reinvested.
The differences in the balances above, as at 30 June 2024, are obviously substantial. Investor 1’s end balance was almost three-times that of Investor 2’s as a result of them having started investing a decade earlier.
And keep in mind that Investor 1, by having started in 2004, would have experienced a major fall in the value of their Australian share portfolio as a result of the Global Financial Crisis between 2008 and 2009.
Over 20 years, Investor 1 had invested $48,500 (their initial $500 investment plus 240 monthly investments of $200). As such their total gain to 30 June 2024 was $74,754.
By the time Investor 2 had started investing in 2014, Investor 1’s starting balance had grown to $35,575.
For Investor 2, their 10-year lag on Investor 1 would have resulted in a much smaller balance at 30 June 2024. After their initial investment of $500, and $24,000 of additional monthly investments of $200, their total gain to the end of the 2023-24 financial year was a much slimmer $16,967.
The mechanics of starting early
Investing is primarily about generating a return on your capital outlay.
A return can be achieved in a number of ways, including via capital growth, regular income, and through compounding.
Leveraging the power of compounding over time is at the heart of investing. An initial starting amount of money is likely to compound if regular ongoing investments are made that also harness the growth returns from the underlying investments.
That’s illustrated in the examples above, where adding small monthly amounts to an initial investment were able to increase significantly for both Investor 1 and Investor 2.
The key difference being that Investor 1, by starting much earlier, was able to leverage compounding investment returns over 20 years instead of just 10.
There’s a lesson here for parents, or grandparents, too.
Investing on behalf of children from an early age, and following a regular investing program, will likely result in them having a sizeable investment balance by the time they turn 18.
Whatever you decide to do, we can work with you to make sure your strategy suits your lifestyle, circumstances and financial goals. Contact us at 08 8231 4709 or info@centrawealth.com.au.
Article courtesy of Vanguard.