If I could only give one piece of advice to someone who wanted to build wealth with a Stocks and Shares ISA, I’d use this quote from Albert Einstein: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
The idea is the power of compound interest is so strong that it’s almost a secret. Take advantage of it and I can earn big. And if I crunch the numbers, I can see how it turns even a modest sum into millions of pounds.
Let me run through an example to show what I mean. I’ll use a £1,000 per month saving and I’ll give it a 10% per year interest – not a crazy amount to expect from the stock market. Here’s what happens.
| £1,000 a month | |||
| 0% | 5% | 10% | |
| 1 year | £12,000 | £12,323 | £12,641 |
| 5 years | £60,000 | £68,090 | £77,172 |
| 10 years | £120,000 | £154,992 | £201,458 |
| 20 years | £240,000 | £407,458 | £723,988 |
| 30 years | £360,000 | £818,698 | £2,079,293 |
Over two million quid! That seems hard to believe when I save only £12,000 a year, but it’s just compound interest doing its stuff. As I reinvest the returns, the interest builds and builds like a snowball that gets bigger as it rolls.
To be specific, I only get £641 interest in the first year. That sound like nothing. After all, how will a few hundred quid turn into a few million? The trick is that the compounding hasn’t got going yet. It doesn’t do much at first.
Ramping up
Even in the second year, I only get back £1,904. That still seems low and a long way off the multimillion figure I’m aiming for, but it’s nearly three times what I got in the first year. I can see it’s starting to ramp up.
By the 30th year though, my interest has shot up all the way to £188,518. Nothing has changed, by the way. It’s still the same deposit. But now the return has grown into an income that might make a City banker blush.
Another way to look at it is that I’ve put in £360,000 but the interest has added around £1,800,000. Most of the money I’d have is from that interest. Without it, a ‘retire early’ figure like £2m is little more than a pipe dream.
It’s true that £1,000 each month might be hard to achieve for some, but even if I dial down the savings, compound interest still rips. A £200 a month saving would turn into £415,859. Still pretty nice and over double the average British pension pot. Not too bad if I can get there.
How to achieve it?
So how do I get this for myself? Well, I need a percentage return for the compounding to work, and investing in companies offers me perhaps the highest I could get. A Stocks and Shares ISA is a great place to start too,as I can avoid paying dividend and capital gains tax on smaller deposits.
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Stocks can be risky, to be fair. I did the maths above with a steady return each year, but stocks go up and down like a rollercoaster.
Equally, nothing is guaranteed with this kind of investing, A 10% return seems doable if I look at past returns from the stock market, but what about the future? Anything could happen. Who knows, a climate crisis might stop humans from making the kind of money from stocks that they did in the past. Yet I feel confident that investing in stocks and reinvesting my returns could unlock great wealth for me.
