Why compounding frequency matters less than you think
Interest compounded monthly rather than annually at the same nominal rate is worth a little more, because each month’s interest starts earning. At 5% the difference between annual and monthly compounding is about 0.11 percentage points a year — real, and much smaller than the difference between 5% and 5.5%.
The rate and the time you leave it alone dominate everything else.
Regular contributions do the heavy lifting
Over a working lifetime, what is added each month usually matters more than the return. A modest monthly amount started early beats a large lump sum started late, because the early money compounds for longer.
Contributions here are treated as arriving at the end of each period. Paying at the start earns one extra period of interest on every payment, which over decades is a visible difference.
What the number ignores
Inflation, tax and fees. A 7% return with 3% inflation is 4% in real terms, and a 1% annual management charge takes a surprisingly large share over thirty years. Growth is also assumed to be smooth, which no real investment is — the average may be right while any particular decade is not.
Frequently asked questions
How much does compounding frequency change the result?
Less than most people expect. At 5%, monthly rather than annual compounding is worth about 0.11 percentage points a year. The rate and the time invested matter far more.
Are contributions counted at the start or end of the period?
At the end, which is the conservative convention. Paying at the start earns one extra period of interest on each payment.
Does this account for inflation?
No. A 7% return with 3% inflation is about 4% in real terms. Tax and management fees are not included either.
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