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I’ve been re-reading the brilliant best-selling book Atomic Habits by James Clear – which, if you’re unfamiliar with it, outlines the small, but ‘stackable’ behavioural changes we can make to turn big goals into actionable and sustainable daily habits. Clear explains that this can be achieved by making it obvious, attractive, easy, and satisfying.
Given it is still early in the year, many of us will be thinking about whipping our finances and investments into better shape, seeking to either embed good habits or jettison bad ones.
YouGov data published in January showed how many of us want to prioritise our financial goals in 2025; in fact, we feel they’re of equal importance to improving our health and fitness.
Paradoxically, though, most of us find saving and investing stressful. In fact, some recent research at interactive investor found that some people would rather bear the stress of taking the tube in peak rush-hour, than endure the stress they associate with managing their finances.
However, by getting a firm grasp of something which Albert Einstein once described as “the eighth wonder of the world,” you can approach your long-term financial goals with more confidence.
The overlooked magic of compounding
According to Clear, a lot of success starts at what he describes as the ‘atomic’ level. This involves starting small, being disciplined, and building the habit – behaviours that are fundamental to becoming a successful long-term investor.
Many of us may have heard (or even said) the phrase: “it will make no impact if I only invest £25/£50/£100 a month, so what is the point?”
This thought process can be challenged, and that’s due to something called compounding.
The following quote, apparently attributed to Einstein (rightly or wrongly), sums it up aptly: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
The principle of compounding is arguably an investor’s most powerful ally.
Why? Investing is a long-term game, and the sheer magic of compounding effectively acts as a buffer against market volatility. It lets time do the work, turbocharging returns and helping to smooth out the bumps and potentially the impact of market fluctuations on your overall returns.
How does it work and how can it help you reach your goals?
Compound interest refers to the reinvestment of interest back into an initial pot of money. Essentially, if you stay invested, you are rewarded over time.
Reinvesting interest or dividends back into an initial pot of money allows investment returns to snowball over time. This can lead to extraordinary gains for investors who are diligent enough to keep drip-feeding money into their portfolios while also having the patience to enable compounding to do the heavy lifting.
For basic illustrative purposes – let’s say you invest £1,000 into a fund returning 5% over one year, you’ll earn £50. Assuming that you don’t withdraw any money, the next year you’ll earn 5% on £1,050, which is £52.50. I know that this doesn’t sound like much initially, but as time passes the compounding effect multiplies. This is where the magic happens.
Generally, as your investment grows, compounding becomes more significant. In fact, there’s a point where growth should inevitably outpace new contributions. Though naturally this will vary depending on the individual’s investment strategy and market conditions.
But broadly speaking, if you are indeed committed to squirrelling away money regularly, staying invested, and being diversified (that doesn’t just mean investing in different stocks, it also means having exposure to different sectors, assets, and regions), even small or modest contributions, increased each year by the rate of inflation, can deliver a sizeable boost to your future wealth.
Once you see the impact of this snowball effect over time, investing becomes a rewarding experience; as James Clear would say, you’re making it attractive.
The earlier you can begin building this habit – the more powerful compounding will be
As with anything in investing, the earlier you can start prioritising this, the better. None of us have a crystal ball, and markets will inevitably peak and trough, but it is all about time in the market, not timing the market. That’s why taking a long-term view works in your favour.
The nature of investing means the annual rate of return isn’t guaranteed – you can earn more or less in a given year, depending on the market environment. But history tells us that, over time, investing gives you a better chance of growing your wealth than keeping your money in cash savings. By committing to an affordable monthly sum as early as possible – ensuring that all expenses can be met and maintaining a rainy-day fund – your future self will thank you. It’s also key to consider ratcheting up contributions whenever you get a pay rise.
The ‘f word’ – fees
Even though we can’t control the market, you can control how much you pay to invest.
Unfortunately, it is not always easy to clearly see the costs associated with your investments – not least the platform charge. But it is well-worth checking how much you are paying.
It can be disheartening to integrate good habits, stick to your investment strategy for the long term and see the fruits of compounding take effect over time, only for your growing pot to be eaten away in unnecessary fees. Over decades, the differences can add up to tens of thousands of pounds. Importantly, paying over the odds means less wealth for you to enjoy down the line.
The information above is for educational purposes only and should not be considered financial advice.
