While we live in a world of cutting-edge technology, new investment classes, and volatile markets, it may seem strange to suggest that time could be your most valuable investment commodity. Only when we investigate further does the actual value of time become apparent.
The value of time
We will now examine different scenarios that demonstrate the real value of time and how it can significantly impact your long-term investment returns.
Compound returns
When looking at time, the greatest visible impact will occur when considering compound returns. This is the process by which annual returns are reinvested, for example, with a bank account where you earn yearly interest, which you can withdraw or leave in your account. Let’s put this into perspective:-
Initial funds: £100,000
Annual return: 10%
Period: 10 years
In the above scenario, you would earn £10,000 interest per annum. If you were to withdraw this interest to cover living expenses, then after ten years, you would have withdrawn £ 100,000. This equates to a 100% return over the period.
Now, let us assume that you don’t withdraw the interest per annum and instead leave this in the account, earning additional interest. After ten years, you would have £259,374 in the account, which, when subtracting your initial deposit of £100,000, equates to a return of 159%. This is the benefit of interest on interest (or additional returns on annual returns).
Short-term timeframes
Obviously, the shorter the time frame, the more pressure there is if you have a particular target in mind. For example, if you have £100,000 in your pension fund (with no further contributions) and a target of £1 million on retirement, different timescales will place more pressure on performance (possibly prompting you to take greater risks).
Using the compound return calculation, these are the annual returns required to hit £1 million over different timescales:-
- Over 40 years, the rate required is 6% per annum
- Over 30 years, this increases to 8% per annum
- Over 20 years and we are now in double digits, 12.5% per annum
The above examples show how shorter timescales would require an increased annual return to hit the same target. It’s obvious, but the value of time here relates directly to the pressure on those managing your funds to hit higher annual returns to achieve your £1 million target.
Pension contributions
Where you’re making regular contributions, the longer the duration of your investment, the more they will likely benefit from compound returns. Let’s look at two different scenarios:-
Client: Margaret
Monthly pension contribution: £50 (starting age 20)
Duration: 40 years
Retirement age: 60
Client: Edward
Monthly pension contribution: £100 (starting age 40)
Duration: 20 years
Retirement age: 60
When looking at their pension contributions, total payments into their pension fund will be £24,000 each. So, in theory, Edward has not been penalised for a shorter duration compared to Margaret. However, the situation changes when we factor in average returns.
If we assume an average annual return of 4%, then due to compound returns, Edward’s pension would be worth just over £36,500 on retirement. Even though Margaret had made the same net contributions to her pension scheme, due to the extended duration and the impact of compound returns, her fund would be worth approximately £60,000 – an additional return of £23,500.
Summary
These examples demonstrate the power and value of time and its significant impact on long-term returns. So, whether looking at basic savings, investments, or pensions (with the added benefit of tax rebates), there is a lot to consider!
If you would like to discuss the benefits of regular long-term investment, please feel free to give us a call, and we can discuss your situation in more detail.