Scott Kingsley, Senior Wealth Advisor
While the most obvious potential benefit from starting early with regular investments is enhanced returns, there are many other factors to consider. Naturally, as investors, our focus tends to be on short-term returns. Only when you look back and consider annualised returns over a longer period can you begin to grasp the real benefits of early regular investments.
We will now look at some of the main factors to consider and how they can shape your finances and your outlook on investment.
The best way to describe compound returns is an increase in the principal investment and annualised returns. This simple example demonstrates the impact:-
Initial investment: £10,000
Average return: 10% per annum
If you were to remove the increase in your initial investment year-on-year, using the average return, you would be withdrawing £1000 per annum. This equates to £10,000 after ten years and an overall 100% return on your investment. After year 10, your funds would have increased in value, including withdrawals, and stand at £20,000.
Let’s assume that you decided to retain your annual increase within your portfolio, thereby benefiting from the additional return on annual growth. Similarly, your initial investment of £10,000 would be worth £25,937 after ten years. This represents growth over the period of 159%, a significant improvement on the first scenario.
Main point: The impact of compounded returns added an additional increase of 59% over the 10-year period.
The potential benefits of compound returns are enhanced even further when you make regular contributions. This also perfectly demonstrates the time-based benefits of starting early with pension plans, with some interesting illustrations in a recent Fidelty article.
Whether you are 16 or 65, financial discipline is critical to controlling your expenditure and long-term investment returns. The earlier you become aware of finances and investment, the pros and the cons, the greater the chances of creating a financial discipline which works for you.
For example, the human mind is focused on habits, so if you regularly contribute to your pension fund, this will become natural, and you won't even think about it over time. However, if you decide month by month whether you will contribute to your pension, there will be a temptation to miss one month, which could become two, and very quickly, your habit will change to one of non-contribution.
The additional benefits of financial discipline also include:-
Historically, finance hasn't been a topic discussed with family and friends, but times are changing. Many parents now realise that the greatest gift they can give their children is an appreciation of the value of money and the benefits of long-term financial discipline.
When looking at investment returns, it is surprising how often we are drawn back to the element of time, an invaluable commodity. For most people, their risk profile will obviously depend upon their finances and personal situation, but the time element will also impact it.
Traditionally, when looking at a long-term investment with retirement in mind, the focus tends to be on growth stocks in the early years, a balanced approach in midlife and a safety-first strategy as retirement looms. This passage also replicates the reducing attitude to risk, focusing on growth stocks gradually reducing until you switch to more liquid, safer assets to protect retirement income. This prompts the question, what is the advantage of investment in higher-risk assets in the early years?
There are two main benefits here:-
Investing in potentially high-risk/high-reward investments can be more lucrative over an extended period of time, assuming you pick the correct investments. If you look at Amazon, the share price experienced huge volatility in the early days, which may have restricted returns for those on a short-term timescale.
Where your investment timescale is measured in years rather than decades, this can be hugely restrictive. For reference purposes, Amazon's share price was the equivalent of nine cents back in May 1997, and today, it stands at circa $180.
With the best will in the world, not all of your high-risk investments will succeed, and you may be forced to take significant losses along the way. Theoretically, if your high-risk investments fail in the relatively early years, this gives you more time to make up losses. For example, a 20% loss on your portfolio is not ideal at any time, but when you are 25 as opposed to 65, the impact on your life is likely to be considerably different.
Recently, we have seen children and young adults take more interest in finance and investment. Thankfully, a topic I am very passionate about has resulted in governments worldwide now including personal finance and investment in their education syllabus. Akin to planting a seed, the benefits of which may take years to emerge, this is a welcome move for parents and their children.
As we touched on above, when saving and investment become a habit, combined with an ability to appreciate the value of money, this is educational dynamite. Children and young adults cannot only learn about finance, but this also prompts them to ask questions and query decisions made by friends and family. Perhaps this is best described as an enthusiastic curiosity.
To paraphrase a famous quote:-
"If you give someone a fish, you feed them for a day. Teach them how to fish, and you feed them for a lifetime."
The obvious extension of this is that children and young adults of today will take the same approach to the next generation, as will the next generation, preparing future generations for their financial challenges.
Whether looking at investment returns or savings, the earlier you begin, the greater your chances of achieving your financial goals. For example, if you decide to buy a house and take out a mortgage, an element of your savings and investments could be used as a deposit to reduce the long-term interest charge. Indeed, for many people, the ultimate goal is to retire early, so by definition, the sooner you start saving for retirement, the more chance of achieving this.
Regarding financial goals, there is one other critical issue to remember. While basing your future thoughts on long-term financial goals is fine in theory, it is useful to have short-term goals to measure your progress. While this may seem like something of a tick-box exercise, achieving short-term targets on the road to your long-term goals can act as a huge incentive.
Ultimately, in a perfect scenario, all your investment and financial decisions will be made in a stress-free environment. In reality, while an element of stress helps focus the mind, too much stress can have a negative influence on your decision-making process. Consequently, when you can start making regular investment contributions, no matter how small, at a relatively early age, this can reduce long-term financial stress.
It not only allows you to build up savings and investments but also creates a buffer between recognised expenses today and unexpected expenses tomorrow. The greater the buffer, the less financial stress and, in theory, the more focused your decisions will be in the long term. This then brings up the issue of mental health, which can be severely impacted by financial pressures, a much broader topic for another day.
When looking through the benefits of starting early with regular investments, you will notice one common denominator, time. It plays a crucial part in:-
It is ironic in the investment world that when looking for the best returns and the more sought-after commodities, we often overlook the most valuable, time.
Financial planning tends to be a statistics-based process for many people who are looking to increase their investment portfolio, create a degree of financial stability, and have sufficient funds to enjoy their retirement. In the long term, however, there is so much more to financial planning, including educating children and young adults, reducing financial stress, and, perhaps most importantly, introducing a degree of financial discipline at a relatively early age.
It's essential to take a proactive approach to your investments, even starting relatively small and then increasing your savings and investments as you go forward. While routine can become cumbersome and tedious in everyday life, in the world of finance, it helps support financial discipline and long-term financial planning. If you get to the stage where your pension contributions are automatic, as are additional regular investments, and you undertake regular reviews, these are great foundations for the future.
When asked about the advantages of regular investment at an early age, many of us would be able to identify the main benefits. Most of these revolve around returns and investment horizons, but there is much more to consider. Such simple actions as planting the seeds of thought in the minds of children and young adults to appreciating compound returns, reducing stress levels and introducing a greater understanding of financial discipline are just the tip of the iceberg.
If you would like to know more about the benefits of starting early with investments and their impact on long-term financial planning, please get in touch today.
It costs nothing to have a conversation, and it could be one that changes your life.