Compounding is the term to describe the magical mathematical phenomenon that occurs when your returns themselves generate future gains (on top of your initial investment).

This ‘interest on interest’ can lead to exponential growth in your wealth over long periods of time and the greatest part is that it requires you to do absolutely nothing – except keeping your money invested, of course. No wonder Albert Einstein once described compounding as the eighth wonder of the world!

Here’s a simple demonstration of compounding in action:

Year	Start of year balance	Market returns	Gains	End of year balance
1	£100.00	7%	£7.00	£107.00
2	£107.00	7%	£7.49	£114.49
3	£114.49	7%	£8.01	£122.50
4	£122.50	7%	£8.58	£131.08
5	£131.08	7%	£9.18	£140.26

The younger you are when you start investing, the more you will benefit from compounding. To demonstrate this another way, consider the following example:

Sam begins saving £100 a month at the age of 30 and does so until they reach 60 years old. With an average interest, or market returns, of 10% they end up with £217,132.11.

Alice started earlier, at age 20, saving £100 a month but stopped when they were 30 years old. They forget about the money saved in the account until age 60, when they are pleasantly surprised to see £367,090.06 waiting for them.

This model proves that compound interest is more effective the earlier you start investing, even if you stop for a bit; saving for 10 years can outperform saving for 30 years if you begin earlier.

Even better still, get into a habit of saving as much as you can and stick with it every single month. Try to transfer out your savings as soon as your salary arrives and think about it as paying your future self. Extra bonus points for setting up a direct debit with your brokerage account or robo-investor so that you don’t even need to think about it.