2 crucial pieces of investment advice to build your retirement portfolio

You absolutely need to understand compound interest to succeed as an investor.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Knowing what to invest in is of paramount importance. But it is also vitally important to know how to invest. Here are two things that I think you absolutely have to understand to succeed in the market.

Understand the power of compound interest

Albert Einstein once said: “Compound interest is the most powerful force in the universe”. He may have been right. The benefit of compound interest can be summarised as follows: the more money you have, the more money you will make in the future, assuming you deploy your capital correctly. This is a pretty simple idea, but one that many people seem to have trouble grasping. 

One key impact of compound interest is that those people who start to save earlier, and invest their savings earlier, will benefit disproportionately compared to those who don’t. An initial £10,000, invested at 5% per annum, will compound to £16,407.09 after 10 years, assuming no deposits or withdrawals – a gain of £6,407.09. 

However, investing that £10,000 for 20 years at the same interest rate will yield £27,126.40 for a gain of £17,126.40. You can see that doubling the savings period increased the overall gain by a factor of 2.67.

Investing that £10,000 for a period of thirty years at 5% will compound to £44,677.44 for a gain of £34,677.44. Tripling the saving period increased the final gain by a factor of 5.41.

So, it’s not just a case of the longer you save, the more money you will have, it’s that your money will compound faster and faster the longer you save. For this reason, it is advisable to start an ISA, and take advantage of pension matching schemes, as soon as possible.

Beware of people saying “this time it’s different”

In October 1929, Irving Fisher of Yale University, one of the most highly-respected economists of his day, declared that stock prices had “reached what looks like a permanently high plateau”. Nine days later, the stock market was hit by the most devastating crash in the history of the US in an event dubbed ‘Black Tuesday’. 

“This time it’s different” is one of the most dangerous phrases that an investor can hear. Some version of this statement will typically accompany the formation of a market top. It is supposed to mean that, although valuations may be expensive by historical standards, investors should buy anyway because a paradigm shift has made the old standards irrelevant.

In the dot.com bubble of the late 1990s, it was believed that new technologies were going to usher in an era of unprecedented economic expansion that would push valuations to brand new heights. 

Economists and commentators seem to have an uncanny ability to make such pronouncements right before the market breaks. In 1999, journalist James K. Glassman and economist Kevin Hassett co-authored a book titled Dow 36,000: The New Strategy From Profiting From The Coming Rise In The Stock Market.

Its core thesis was that stocks would soon be considered as risk-free as bonds and that the market would price them accordingly. When this happened, the fair value of the Dow would be around 36,000. Twenty years later, the all-time high for the Dow stands at 27,398 (set earlier this year).

When someone tells you that this time is different, assume it probably isn’t.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Neither Stepan nor The Motley Fool UK have a 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.

More on Investing Articles

Investing Articles

Should I still be cautious about Rolls-Royce shares?

Rolls-Royce shares are flying. But is now the time for this Fool to open a position? Here, he explains why…

Read more »

Group of young friends toasting each other with beers in a pub
Investing Articles

Is the Diageo share price coiled to rebound?

Christopher Ruane explains why he remains bullish about the long-term outlook for the Diageo share price and would happily invest…

Read more »

Young Asian woman holding a cup of takeaway coffee and folders containing paperwork, on her way into the office
Investing Articles

How I could make a 10% yield for high passive income a reality

Jon Smith explains how he can target high passive income from top-yielding stocks, including one specific example he'd consider.

Read more »

Investing Articles

I’d buy 1,784 shares of this FTSE 100 stock to target £350 of monthly passive income

Muhammad Cheema takes a look at how British American Tobacco shares, with a dividend yield of 10.1%, can generate a…

Read more »

White female supervisor working at an oil rig
Investing Articles

1 ex-FTSE 100 stock that I think will get promoted soon

Jon Smith flags up an energy stock that used to be in the FTSE 100 and currently has strong momentum…

Read more »

Shot of a young Black woman doing some paperwork in a modern office
Investing Articles

With an 8% dividend yield, I think this undervalued FTSE stock is a no-brainer buy

With an impressive yield and good track record of payments, Mark David Hartley is considering adding this promising FTSE share…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

£9,500 in savings? Here’s how I’d try to turn that into £1,809 a month of passive income

Investing a relatively small amount into high-yielding stocks and reinvesting the dividends paid can generate significant passive income over time.

Read more »

Businesswoman analyses profitability of working company with digital virtual screen
Investing Articles

Dividend star Legal & General’s share price is still marked down, so should I buy more?

Legal & General’s share price looks very undervalued against its peers. But it pays an 8%+ dividend yield, and has…

Read more »