Early saving outpaces larger late contributions in compounding example

Starting retirement contributions at 25 with £100 a month could produce a larger pot by 65 than beginning at 40 with £300 a month, according to an example set out by Dmytro Spilka, director and founder of Solvid and Coinprompter. His calculation assumes a 7% annual investment return and shows the earlier, smaller contribution reaching £262,481, compared with £243,022 for the later, larger monthly payment.

The comparison highlights the role of compounding in long-term saving and investing. In Spilka’s example, the person starting at 25 contributes £48,000 over 40 years, while the person starting at 40 contributes £90,000 over 25 years. Despite the lower cash contribution, the earlier saver ends with the higher balance because returns have more time to generate further returns.

How compounding changes the calculation

Compounding occurs when interest, dividends or investment gains are retained in an account and then themselves earn a return. In a savings account, interest can be added to the principal balance, increasing the base on which future interest is calculated. In an investment account, gains can remain invested, expanding the portfolio that participates in future market movements.

Spilka said the effect can be more pronounced for investors than for cash savers because markets have generally delivered higher long-term returns than fixed-rate savings products. He also noted that investment outcomes are not guaranteed and that investments may not outperform savings accounts in every period.

Under the 7% annual return assumption used in the example, the saver beginning at 40 would see £90,000 of contributions grow to £243,022 by age 65. That implies gains of £153,022 before considering any fees, taxes or other account-specific factors not detailed in the calculation.

The saver beginning at 25 would contribute £48,000 over the same endpoint and reach £262,481 by age 65. Spilka’s figures put the implied gain at £214,481, reflecting the additional 15 years over which earlier returns can remain invested and generate further growth.

Tax wrappers and advice routes

Spilka also pointed to Stocks and Shares ISAs as one way UK savers and investors can hold investments in a tax-efficient account. UK government rules cited in the discussion set the annual ISA contribution limit at £20,000, equivalent to monthly payments of up to about £1,666 if spread evenly across a year.

MoneyHelper says Stocks and Shares ISAs allow investments to be held without UK tax on eligible income or capital gains within the wrapper, subject to ISA rules. The suitability of such accounts depends on an individual’s circumstances, risk tolerance and investment horizon.

For people uncertain about how to begin, Spilka referred readers to financial advisers and to MoneyHelper, the government-backed service that provides free and impartial guidance. His wider argument is that timing can be as important as contribution size when returns are reinvested over long periods.

This story draws on original reporting from Finextra Research.