A little-known pension rule could be boosting savers' pots by thousands of pounds, with compound investment growth accounting for the majority of many retirement funds. For a typical defined contribution pension pot of £100,000, around £65,000 of the value comes from compound investment growth, according to figures from Standard Life.
How Compound Growth Works
Pensions grow into large nest eggs because they benefit from compound investing growth, where investment returns generate further returns over time. This compounding effect means that money invested earlier has more time to grow exponentially.
Marianna Hunt, personal finance specialist at Fidelity International, said in an update for pension savers: "The sooner your money is invested, the longer it has the opportunity to grow and benefit from compounding, where investment returns can themselves generate further returns over time."
Start Early and Stay Invested
Hunt added: "Starting early also means you don't necessarily need to begin with large amounts. Even relatively small, regular contributions have longer to build, while delaying can mean having to put away more later to achieve the same goal."
Tips for savers include starting early and never opting out of pension schemes. Jenny Holt, customer savings and investment director at Standard Life, said: "This is why starting early can make such a difference. Even modest contributions made earlier in your working life have longer to benefit from potential compound investment growth, while delaying saving can mean missing out on the years when your money could have been working harder for you."
Avoid the Default Fund Trap
Another option is to encourage employers to contribute more free cash and avoid the "default" fund trap. Sarah Coles, head of personal finance at AJ Bell, said: "If you haven't made a decision about where to invest, you're likely to be in the default fund, which tends to be middle-of-the-road so it's a reasonable choice for the average person. However, if you can get to grips with pension investments, you can tailor yours better to your needs. For those earlier in their career and comfortable with more risk, this could mean more growth potential."
The compounding effect demonstrates why starting pension contributions early, even with small amounts, can lead to significantly larger retirement funds over time. Savers who delay may need to contribute more later to achieve the same retirement outcome, according to the experts.
