Compounding confounds savers: Ward

The chief economist for Henderson Global Investors warned that, with low asset growth and low interest rates, the power of compounding to help people build up savings over time was weaker than in the past.

Mr Ward said: “With asset price inflation likely to slow, households need to raise their financial saving to meet wealth targets, particularly with compounding doing less of the work than in the past. However, too rapid an adjustment in aggregate saving would threaten economic growth.”

Compounding, or compound interest, is where an investment generates earnings by itself, for example by reinvesting dividends or interest. According to Albert Einstein, compounding was the ‘greatest mathematical discovery of all time’.

Scott Gallacher, director of Leicestershire-based Rowley Turton, said: “Mr Ward makes an interesting point on compounding.

“As interest rates are lower people do need to invest a bigger lump sum to give them the income they need. Generally, people have not woken up to the fact that final salary schemes have gone and the welfare state cannot continue to support them.

“People are not starting to save until much later in life and there are a lot of people who will have a huge financial shock when they get to state retirement age with low levels of saving, living far longer than perhaps they expected. They need to be saving more, from a younger age.”

Chris Williams, chief executive for Bristol-based Wealth Horizon, said: “Investing requires a certain level of knowledge and expertise. You need to understand the importance of a diversified investment portfolio, have an appreciation of investment timeframe, and be aware of things such as liquidity and the trade-off between risk and return.

“It is certainly not something to be taken lightly and the financial stakes of getting it wrong should not be underestimated. The chances of investing in an unsuitable investment are high if you don’t know what you are doing.”