Save smart, retire rich: the power of compound

January 20th 2025

Retirement: If you are in your 20s or 30s, this might seem like a lifetime away and you may think there is still plenty of time before you need to start preparing for it – but is that true?

If you are planning on relying on the Old Age Pension to support you in retirement, did you know that for those in Guernsey born after 1^st March 1979, you will have to wait until you reach age 70 before you are eligible for the Old Age Pension. Similar increases are expected in the UK in order for the UK’s Old Age Pension to remain affordable.

With the recent roll-out of Secondary Pensions in Guernsey, it has put a spotlight on the importance of saving for retirement. Pensions can offer great incentives for savers with contributions benefiting from tax relief, and the potential to withdraw a tax-free lump sum from age 50.

As a financial adviser, I am often asked, “How much do I need to contribute?” and “Am I too late to start saving for retirement?”

The answer to the above: it depends on your circumstances and priorities. We do have to be realistic with time being a limiting factor; however, whatever age you start, the power of compounding can be a real a game changer in meeting your goals.

What is Compounding?

Compounding is the principle that any growth on your initial investment also achieves growth on itself. In other words, for every year your investment grows in value, you are also benefiting from growth achieved previously.

As an example, if you contributed £1,000 at the start of the year, and your investment achieved 5% growth, at the end of the first year you will have £1,050. In the second year, you contributed a further £1,000 at the start and earned a further 5% growth, your investment will be £2,152.50, and so on. Compounding even works with one-off lump sum, say £50,000, could potentially be worth around £132,665[1] in 20-years’ time.

Over time, this snowball effect can result in exponential growth, making compounding a very powerful tool for long-term savers.

Why Start Early?

It is easy to feel like you have plenty of time before you need to worry about retirement, and it is only natural to make decisions based on today’s needs rather than worrying about tomorrow. A phenomenon called hyperbolic discounting where “people give more weight to rewards/costs that are closer in the present than those farther in the future” [2] is particularly relevant today, when living costs are increasing and household budgets are being squeezed.

But why should someone 20-30 years away from retirement pay much heed to this?

• Time is a key factor in compounding because the more time your money has to grow, the larger your retirement pot will be. This means even small contributions made earlier in your career can grow significantly over decades.
• Compound interest grows exponentially too, so your interest is earning interest.

To put this into perspective, if you were targeting a £300,000 retirement pot at the age of 65, and assuming modest growth of 5%, a 25-year-old with 40-years until retirement would only need to save £207 per month, compared to £756 per month for a 45-year-old with 20-years until retirement.

Therefore, the benefit of compounding can turn a modest, regular contribution into a meaningful nest egg. 

 

Maximise the potential of compounding

Whilst time is a key factor, if you feel like you may have left it too late, here are some practical approaches you could consider to maximise the power of compounding:

• Start as soon as you can. The sooner you prioritise retirement savings, the more time your money has to grow
• Be consistent - ensure you are continually building your pension fund
• Increase your contributions over time. As your earnings increase, try increasing your contributions. Using the example above, if you were to double your contributions halfway through a 40-year timeframe, you could potentially increase your retirement pot by a further £76,645;[3]
• Employer matching. Take advantage of employer matching incentives so you do not miss out on additional contributions, which can make a significant difference to what you could potentially retire with

One last point

The power of compounding can be an effective tool for growing your retirement pot and help to set you up for a more secure and comfortable retirement. The being said, a financial adviser can talk to you about all your options and help you put a realistic plan in place, ensuring that you can still enjoy today, whilst not worrying about tomorrow.

Arrange a free financial review with one of our qualified independent financial advisers: email advice@network.gg or call 01481 701400.

 

[1] Calculations based upon 5%pa investment returns.

[2] Samson, A. (2017). The Behavioral Economics Guide 2017. Behavioral Science Solutions.

[3] Based upon a 5% average growth rate and contributions of £207pm for the first 20 years, followed by £414pm for the remaining 20 years