As a lad, I used to save regularly in a post office savings account. Every week, I’d spend some of my pocket money on sweets from the corner shop then take the rest to the post office. The man behind the counter would take my money and stamp my savings book.
Soon I had enough saved and accrued interest to make a larger purchase. One day I withdrew most of my savings and bought my first adult-sized bicycle.
The power of compounding
Then I forgot about my post office savings account altogether and never used it again. Years past. Then, when moving home, I found my old post office savings book.
The book showed a deposit of around £4. I hadn’t entirely emptied the account when buying the bike all those years ago. Although tempted to forget about it, out of curiosity I went back to the same post office on the corner and presented the book. To my amazement, the same man (but looking 15 years older) put the book under a special machine that whirred and typed and printed out line after line of interest that had accrued over the years on the money in the account.
When it had finished he handed me £18.76. I was amazed the money had grown so much, but that’s the power of compound interest, where interest is added onto the principal amount and onto accrued interest. Compound interest makes money get larger and the rate of expansion accelerates over time.
In the post office account, my money probably kept pace with inflation and no more. So in terms of spending power, I ended up with a similar amount I started with. However, historically, the stock market has delivered total returns to investors in excess of inflation, which means the process of compounding can work to grow the real value of your money over time and create wealth.
Building wealth with shares
I wish I’d embraced the concept of compounding more fully when I was 25 and invested regularly on the stock market. For example, saving just £500 per month for 30 years and earning an average return of 8% a year on the stock market will deliver a pot of savings worth just over £700,000. I wish I’d done that with my money starting all those years ago.
If I was starting at 25 now, I’d put money each month into the stock market via a low-cost, passive index-tracking fund, such as one that follows the fortunes of the FTSE 100 index, or perhaps the FTSE 250 index. Alternatively, I’d invest regularly into larger, stable and dividend-growing shares.
There are many ways to approach stock market investing. But the key to success, in my view, is to keep the idea of compounding in mind.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.