Page 2 - Wealth-Adviser-Issue-119 (FWP)

ISSUE 119
SEPTEMBER 2025

provided you reinvest your earnings. Each time you make a Why Do So Many Miss Out? Behavioural Pitfalls
contribution or earn dividends or interest, your next return and Common Mistakes
is calculated on a bigger base. Despite compounding’s power, many Australians fail to
Let’s break this down with some familiar numbers: take full advantage—and the reasons are as much psycholog-
Suppose you invest $500 per year at 3% per annum. After 20 ical as financial.
years, you’ll have accumulated nearly $13,838—well above First, investors may be too conservative, sticking to cash
your $10,000 of contributions. If the average return rises or defensive assets that feel safer but offer lower returns and
to 7%, the final sum climbs to nearly $21,933, with annual hence, less compounding potential. It’s common, especially
investment earnings in year 20 dwarfing those in year one. after volatile market episodes, to “go to cash” and miss out
But introduce an upfront contribution—say, $2,000—to kick on the periods when markets recover and compound growth
off that same investment at 7%, and after 20 years, you’ll resumes.
have nearly $29,672. Second, starting late or saving too little at the outset is a
The upward curve becomes truly dramatic over long time costly misstep. The magic of compounding relies on time;
frames. Given enough time, even modest regular invest- each year delayed is a year lost for growth on past growth.
ments can snowball into a sizable nest egg. As many advis- Even small sums, invested early, can outpace much larger
ers put it: the longer the period, the more it works. After ones started later in life.
40 years, a strategy with regular contributions and a higher Third, many attempt to “beat the market” by timing
return compounds to an astonishing sum. This exponential entries and exits, or frequently trading in search of the next
acceleration is why prudent investors, regardless of start- big thing. These efforts more often destroy wealth, as buy-
ing income, can build meaningful wealth given time and high, sell-low behaviour takes hold when emotions overrule
discipline. discipline. The result is missing out on market rebounds—
the very times when compounding has its greatest effect.
Growth Assets: Stronger Compounding Lack of diversification is another common error.
What you invest in matters almost as much as when and Concentrated portfolios, or “putting all the eggs in one
how much you invest. Over Australian financial history, basket,” can reverse years of compounding progress with
growth assets—shares and property—consistently outper- a single bad outcome. Cross-asset diversification—mixing
formed defensive assets like cash and bonds, especially shares, property, cash, and fixed income—provides a
when compounding works its magic over decades. smoother, more resilient ride for the long run.
Growth assets like shares and property provide higher Finally, many get tempted by trendy investments prom-
returns than defensive assets like cash and bonds over long ising a “free lunch,” only to discover that outsized returns
periods, as their growth potential drives higher long run often come with risks that jeopardize both capital and
returns, compensating for their higher volatility. Since 1900, compounding prospects. Simple, disciplined, long-term
the $1 invested in Australian shares (with dividends rein- investing in proven vehicles remains the best approach.
vested) would be worth over $1,000,000 today, compared The fundamental behavioural challenge is resisting the
to just $994 for bonds and $272 for cash, simply because short-term noise of markets, headlines, and social media.
shares delivered higher, volatile returns that compounded Emanuel Derman likened compounding to “letting tiny, in-
over a longer timeframe. visible steps accumulate into a journey of a thousand miles.”
Even over rolling 20-year periods, Australian equities Resilience—staying invested through ups and downs—is
have almost always outperformed cash and fixed income, perhaps the most underappreciated investor skill.
despite periods of market turmoil. Historical Australian
property returns are close to shares—about 10.8% annual- Practical Steps for Every Investor: Harnessing
ised since the 1920s, compared to 11.2% for equities—again the Magic Multiplier
demonstrating compounding’s results with long-term Fortunately, the magic multiplier of compounding is
exposure to productive, growing assets. available to every Australian, regardless of starting sum or
The message is clear: higher-returning, growth-focused market knowledge. Here’s how to ensure it works for you:
investments are essential to fully harness compounding. • Start Early and Invest Regularly: The earlier you begin,
Volatility is the price of admission, but history leans heav- even with small amounts, the greater the compounding
ily in favour of those who stay the course. This holds for effect. Make use of regular or automated investment
superannuation as well: members who choose high growth plans, salary sacrifice into super, or direct debit into man-
investment options early in their careers tend to accumulate aged funds or ETFs.
far larger balances than those who opt for overly conserva- • Focus on Growth Assets for the Long Run: Allocate a
tive allocations. substantial portion of your portfolio to shares and prop-

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