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Time is money: the beauty of compound interest

Are you putting your money to work or letting it lag?

By Daniel Lane, Fidelity Personal Investing

If you really wanted to, you could watch share prices move by the second, and read about why they’ve moved nearly just as quickly. In the age of high-frequency trading apps and live share tips it can be hard to keep up.

And we don’t really value the speed of it all anymore, we expect it.

The temptation to invest now and think later is all too real, to the extent that sometimes we can lose track of the golden rule of investment: it’s not about timing the market, it’s about time in the market.

The reason why time will outlast any market hunch or algorithm is the power of compounding. While other theories might have their merits and burn with a brief and beautiful flame before something else comes along, compounding is here to stay; time will keep on going despite us.

Interest on interest on interest

Earning interest on our savings is the reason we use institutions rather than keeping our money under the mattress but it comes in two flavours: simple and compound.

With flat-rate or simple interest, the first interest payment you receive on top of your savings will be exactly the same as the very last interest payment you receive. No more, no less.

Compounding amplifies that effect by earning interest on top of the initial amount as well as any interest built up over time. The first interest payment will be the same as in the first case but, as the snowball effect gathers speed, your savings can too.

The difference in outcome is down to patience and letting your money do the work over time. Creaming off the interest when you get it prevents that all-important compounding effect but if you keep reinvesting it you give your savings the best chance of growing over the long term.

Leave it alone

Tinkering with our investments is tempting but the best thing we can do is leave our money where it is and even start to add a bit more over time. It doesn’t have to cost the earth and, importantly, you don’t have to stay glued to your phone, watching the markets move.

With compound interest, the only asset you need is time. The earlier you can lock your money away, the more time you will give it to generate that compounding effect. Don’t touch it, let time work its magic and you could reach your financial goals sooner than you think.

Important Information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.