# Compounding Effect

*Don’t worry about the maths, look at the graphs.*

In the Simple Investing course we explain why compounding is important. Here are some graphs to help you avoid the maths.

We’ll look at the effect of returns and charges on pension pots created by saving £1000 per year for any period up to 40 years.

Here’s what you’ll get at 2,3,4,5% for up to 40 years:

*Pension pots at annual returns of 5, 4, 3 and 2 % for up to 40 years.*

So small changes in return over 40 years make a big difference. How much difference?

Suppose your pension payments are invested at 5% per annum. And suppose you are charged 3% per annum in fees. So the return you will actually *get *is 2% per annum. The graph shows that after 40 years your pot will be worth £60,000 instead of £120,000. A 50% loss.

Would we get a different picture if investment returns were higher? Surely the effect of charges on an 8% return fund would be proportionately less than they would be on a 5% return fund? Let’s have a look.

*Pensions pots at annual returns of 8,7,6 and 5 % for up to 40 years.*

*Pensions pots at annual returns of 8,7,6 and 5 % for up to 40 years.*

Looks worryingly similar, doesn’t it? The *values *are much greater (look at the scale on the Y axis) but the shape and relationship look the same. As indeed they are……

There is the same 5% return graph giving you £120,000. But now the 5+3=8% graph ends at £250,000. Once again, at 3% charges you lose half your pot after 40 years.

Let’s be clear. The issue here is psychological, not mathematical, and it applies equally to returns as to charges. An extra return of 1% per annum ‘does not sound like much’. Charges of 1% per annum ‘do not sound like much’. Particularly when your service-provider tells you what your £1,000 per year is going to grow to. But mathematically they mean the same in both cases. And are just as damaging.