Compounding is such a wonderful concept, I wonder why more people don’t take advantage.
In a typical building society deposit account, the saver receives ‘interest.’ This interest is added to the original capital and becomes part of the following years capital. Further interest is added in year two. Interest is now being paid on previous interest. In year three, we now have interest on the interest on the interest. In year four, ….well you get the idea!
Double your money
If interest rates were at just 3%, then your original capital would double over 24 years. Yes, £50,000 would become £100,000 assuming the tax man was held at bay. An ISA account could do this. If interest rates were 6%, then your capital would double over just 12 years. Ah, I hear you say, interest rates are so low.
The building society guarantees your capital.* The good news is you won’t lose capital. The bad news is your capital itself can’t grow. How can capital grow in itself?
The answer is if that capital is invested in real assets. For example a house. A house can produce BOTH capital growth and income growth. After a year house prices may have risen, and if we rented it out, we may also have an income or interest.
Which investment types would you pick?
A house may be a great long-term investment. However, it comes with risk and some work and costs. The risk is that sometimes values may fall, your capital isn’t guaranteed! The work is that you need to maintain it. The costs are those of purchase, legal, stamp duty, repairs, and maintenance.
Stocks and shares can also give you BOTH capital and income growth. The underlying businesses can appreciate in value, as well as paying an annual income in the form of a dividend. In fact, all firms are always trying to grow.
Risk-tolerant investors love picking companies to invest in. They do their research and back their opinions. Some are very good at it, others not so. Predicting the stock market is a dangerous game. Many have become unstuck.
Are you risk averse?
The majority of us are risk averse, especially if we have worked hard all our life to put a bit away. Even owners of small businesses who took risks in their younger days become much more cautious as retirement approaches.
So how can you take advantage of BOTH capital growth and income growth, and yet at the same time control some of the inherent risks?
Spread your risk
The answer is to spread the risk amongst many asset classes, all at the same time. Collective Investments are now main stream and available with or without financial advice. A typical portfolio will include 15-20 funds across the different asset classes. Each fund may hold up to 80-100 individual investments. That’s thousands of underlying investments all held in one pot.
Asset classes such as equities, gilts, property, corporate bonds, cash, all typically behave in certain ways to each other. These correlations can be calculated and used to create portfolios with different risk expectations.
All of this can then be wrapped up in an ISA or a Pension Fund. So there you have it. You have no excuses. We can all benefit from BOTH capital and income growth. What a wonderful thing is COMPOUNDING.
If you wish to discuss Cash ISA’s or arrange a Pension review then please contact Mark O’Neill at Jones Harris Chartered Financial Planning on: 01253 874255 or email: firstname.lastname@example.org
*The value of investments or income from them may go down as well as up. Cash investments with eligible building societies are protected up to a total of £85,000 by the Financial Services Compensation Scheme (FSCS), the UK’s deposit guarantee scheme.
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