With savings, every little bit counts. In our view, one should focus on regular contributions to investment portfolios to build an asset base, in turn allowing investment gains to compound over time and further bolster accumulated assets. In addition to the notion that even small amounts of savings, when invested according to a disciplined strategy, may grow substantially over time, we think the following additional thoughts are important for savers to consider:



* The compounding of returns may add to the proportion of portfolio assets that earlier savings and gains on those savings helped build* And those compounded gains in absolute dollar terms may become increasingly large with time* Seemingly small changes in long-term returns can have a relatively outsized impact on the eventual value of an investment portfolio



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Savings are Good…



To demonstrate the potential power of a regular savings and investment plan, we created a hypothetical portfolio built using $100 per month in savings that’s invested at an annualized return equal to that achieved by an index reflecting a 60/40 mix of equity and fixed income over the past 40 years. Past performance is not indicative of future performance and one cannot invest in an index, but we think the long-term return of 10.0% achieved by that index sets a reasonable basis for this demonstration. To start the discussion, we show in Figure 1 the proportion of accumulated portfolio value achieved by savings, versus the value achieved by having theoretically invested those savings. After 5 years of savings, the investment gains represent just a bit over a fifth of the portfolio. Not much, but still meaningful. But if one leaves those savings invested, they, too, may grow as returns “compound” over time. After 25 years, those gains represented three-fourths of the portfolio in this hypothetical scenario, a proportion that continued to grow.







…Gains on Savings Even Better



The longer one can save, the longer those gains may compound and the potentially larger the portfolio may become, even as the savings rate might remain relatively small. It’s helpful to think about the extra years of savings as being added at the end of the accumulation phase, rather than at the beginning. And that’s because the later years are when compounding can prove most impactful in terms of absolute dollars. To see how the math works we can break up each month of savings into its own “portfolio”. The first $100 had most of forty years to grow at that near 10% annualized rate, eventually expanding to be worth $4,472. The second month of $100 savings grows at that same rate for 478 months to $4,437. And so on, all the way to month 480, by which time the $48,000 in savings may have grown to a considerably larger sum.



Picking up where we left off in Figure 1, we show the absolute dollar amounts of that hypothetical portfolio built from savings of $100 per month. The substantial boost to long-term growth from compounded returns shows up even more starkly in this view, which includes the hypothetical portfolio value at the end of each year. From a comparatively small $48,000 in total savings, all that compounding of returns in this demonstration results in subsequent gains of more than half a million dollars.