Snowball effect: How wealth accumulation will work in 2025
Whether it’s financial freedom, retirement planning or other reasons, all these goals are much easier to achieve if you invest your money and use the snowball effect to your advantage. You can benefit from this efficient investment strategy by letting compound interest work for you. In this article, we’ll show you exactly what the snowball effect and compound interest mean and how you can use them to build your wealth!
In brief:
- We will show you what the snowball effect or compound interest effect means and why it is important for building your wealth.
- Investors should consider these three factors in order to optimise the snowball effect and maximise profits.
- You can learn which asset classes are best suited to take advantage of the snowball effect.
What is the snowball effect?
The snowball effect and compound interest effect are synonymous with each other. Imagine you invest a certain amount in shares, for example. The aim is to invest money for the long term and benefit from dividends and increases in value. You’re wondering, ‘What are dividends?’
After just one year, you have already achieved a certain percentage of profits:
- You can now reinvest these profits.
- In this way, the principal amount that earns interest for you becomes increasingly larger.
- The amount of money working for you keeps growing, and this way, you can build up your wealth faster.
- Wealth accumulation through compound interest can be described by exponential growth.
Put simply, this means that you can accumulate more wealth if you do not withdraw your money. Instead, you can reinvest your profits. The original starting capital will grow every year. This way, you can increase your future returns.
Good to know:
Companies can use the profits they generate in different ways. One option is to pay out part of these profits to their shareholders in the form of dividends. Alternatively, they can build up their financial reserves, invest in research or tackle new projects.
Example of the snowball effect
This theoretical explanation is easier to understand with a concrete, practical example. Imagine two people. Person A invests €10,000 in a fixed-interest product. The return is 5 per cent per annum.
Person B also invests €10,000 in the same product. Person A now decides to take advantage of compound interest and reinvest the profits. Person B wants to treat themselves at the end of the year and therefore decides to have the profits paid out annually.
If €10,000 is invested at 5 per cent, this results in a profit of €500. Person B has this money paid out at the end of the year and can make another €500 profit the following year. After two years, Person B has a total of €11,000: €10,000 was invested and €1,000 in returns was generated.
Person A reinvested the €500 profit generated in the first year directly. The base amount after one year, which generates interest for Person A, is already €10,500. This means that Person A’s total contribution after two years is already €11,025, while Person B has a total of €11,000.
After two years, this effect may not seem too significant, but due to exponential growth, it will become apparent in the long term. Especially if you are pursuing long-term financial goals, such as retirement planning or financial freedom, you can benefit greatly from taking advantage of this effect.
Let’s look at another example. Suppose a person wants to invest €100 per month at an annual return of 5 per cent. How much can that person benefit from the compound interest effect?
| Investment horizon | Paid in by yourself | Generated through interest | Final capital |
| After 20 years | 24.000 Euro | 16.746 Euro | 40.746 Euro |
| After 40 years | 48.000 Euro | 100.856 Euro | 148.856 Euro |
In these examples, you can see that the snowball effect can make a significant difference and that it is definitely worth considering certain aspects in order to increase the compound interest effect. But what aspects do you need to pay attention to?
What do I need to bear in mind with the snowball effect?
The strength of compound interest also depends on which asset class you choose. If you opt for traditional investments such as savings accounts or building society savings agreements, the effect will be less pronounced due to low returns. You can therefore benefit particularly from high-yield investments.
The investment horizon is another aspect that can increase the effectiveness of your compound interest. The larger your initial sum, the more profits you can make. Therefore, you can benefit most from compound interest if you pursue a long-term investment.
- If you are considering a strategy for building your wealth and would like to make an assessment, you can use various websites on the internet.
- These often offer a calculator.
However, you must bear in mind that inflation is often not taken into account! Inflation describes a fundamental increase in prices, which can increasingly devalue your money. Over time, you will be able to buy fewer products and services for the same amount of money.
Taxes must also be deducted from the final amount. This includes withholding tax and possibly church tax. This shows that the compound interest effect is hardly worthwhile for investments with low returns.
In addition, the amount you invest influences the snowball effect:
- However, this does not mean that you have to invest large sums of money immediately in order to profit.
- If you currently have small amounts of money available, you can set up savings plans, for example.
- You can adjust this at any time and increase it in the future if your financial situation allows.
Good to know:
In summary, you can benefit most from the compound interest effect by optimising your investment horizon, base amount and asset class. These three factors have a decisive influence on how significant the snowball effect will be in building your wealth.
Which types of investment allow you to benefit from the snowball effect?
How can you invest your money wisely to maximise the snowball effect and optimise your investment strategy? As we have already established, you need high-yield investments to do this. In this section, we will introduce you to some suitable options!
Shares
Investing money in shares to benefit from the compound interest effect? Yes, it works! Shares are issued by companies and can be traded on the stock exchange. Companies issue them to shareholders in order to increase their own capital.
When you buy a company share, you acquire a stake in that company. Investors try to profit from positive performance and dividends. Long-term investors want to find undervalued shares so that they can sell them at a higher price at a later date.
The share price is determined by supply and demand. If demand rises, for example, the share price also increases and buying becomes more expensive. Demand depends on many factors, such as political changes or decisions relating to the specific company.
An investment comes with attractive benefits:
- Opportunity for strong returns through price increases and dividends
- Possibility of passive income through dividend strategy
- Inflation can be offset
- Flexible trading (can always be bought and sold during official trading hours on the stock exchange)
- Very large selection
- Shareholding in a company and associated rights at the annual general meeting
In addition to these opportunities, there are also risks for investors. These include, for example, price fluctuations, which are part and parcel of trading on the stock market. These fluctuations are accompanied by risks of loss. A long investment horizon is recommended in order to balance out price fluctuations.
Furthermore, investing in just a few companies is very risky due to a lack of diversification. If you invest only in one company that performs worse than expected, you could incur heavy losses. If a company becomes insolvent, you could lose your entire investment.
Finally, the research is time-consuming. It takes a considerable amount of time if you want to decide on specific companies. You need to find out more about the company itself, its plans for the future and specific key figures, and analyse these if you want to develop your strategy.
Good to know:
Therefore, make sure to spread your assets across many companies from different countries and operating in different industries. If one company goes bankrupt, profits from other companies can offset these losses.
ETF
An ETF, or exchange-traded fund, is an index fund that is traded on a stock exchange. Investors can jointly contribute to a fund. This money is used to invest in a specific asset class. With the help of ETFs, investors can invest in bonds, shares or commodities, for example.
One example of an index is the DAX. An ETF on the DAX invests in the 40 largest German companies. With the help of such a security, it is therefore very easy to invest in a large number of companies. This opportunity for diversification is one of the key advantages of ETFs. ETFs also offer the following advantages:
- attractive potential returns
- Beginner-friendly & easy to understand
- Low fees
- Little research required
- Savings plan possible & flexibly adjustable
- Transparent asset class
- High security when the fundamentals of investing are taken into account
Like shares, ETFs are traded on the stock market and are therefore subject to price fluctuations. You should only invest money that you will not need in the next few years, so that you are not forced to sell at unfavourable prices at any point.
Special ETFs, known as thematic ETFs, are also risky. They enable investors to invest in specific areas, such as innovative technologies that could play a major role in the future. However, this development is unpredictable. Since these securities invest in the same area, diversification is significantly limited here.
Furthermore, ETFs only offer average returns. They are classified as passive funds. Active funds are managed by a fund manager who puts them together with the aim of outperforming the average market return. Passive funds, on the other hand, aim to track their index as closely as possible. Global ETFs aim to achieve the average market return.
Good to know:
However, experience shows that it is highly unlikely that an active fund will consistently generate excess returns over a longer period of time. Active funds have another particular disadvantage: the fund manager has to be paid, which is why the fees are significantly higher than for an ETF.
P2P
P2P stands for ‘peer-to-peer’. These are lendings granted between two private individuals without the need for a bank. The advantage for borrowers is that there is significantly less bureaucracy involved. Lenders can lend their money and earn interest.
So-called P2P Platforms act as intermediaries and ensure that lenders can find suitable P2P lending. These platforms divide borrowers into so-called credit ratings, which are intended to enable lenders to assess the risk of an investment. This is intended to ensure transparency for investors.
Investors can invest easily and automatically on most P2P platforms. To do so, they select certain parameters, such as how risky the investment may be and what return is to be achieved. The programme then invests automatically. The
- Opportunity for attractive returns
- Opportunity to support private projects
- Opportunity for diversification
- Easy-to-understand asset class
This asset class also carries risks. Loans may default because a borrower is unable to repay the amount including interest. You can counteract this risk with strong diversification so that profits from other loans can offset potential losses.
In addition, credit ratings may be incorrectly assessed by P2P platforms. This form of investment is still relatively new, and the platforms are therefore rather inexperienced. Borrowers may enter incorrect data, or the platforms may underestimate the risks.
There is also the risk of the P2P platform becoming insolvent:
- Most of these platforms have introduced security measures in case such difficulties arise.
- However, as this type of investment is still relatively new, the platforms have no experience with previous insolvencies.
- You can use various P2P platforms to diversify.
- In addition, you should only use British providers to increase security and improve communication.
Conclusion: Build wealth with the snowball effect
The snowball effect or compound interest effect is an excellent way to make your wealth accumulation more efficient. It involves reinvesting your profits so that your basic assets, which work for you and generate further returns, grow increasingly larger. In this way, exponential growth can be achieved.
If you want to optimise the snowball effect, there are three different aspects to consider. Your investment horizon, your invested assets and your asset class are all linked to the strength of the compound interest effect. When planning your assets and future returns, you should also take tax and inflation into account.
In principle, high-yield investments are ideal for maximising the snowball effect. We have presented three different types of investment that can help you achieve this: shares, ETFs and P2P lendings. This way, you can steadily increase your assets over many years and achieve exponential growth!
You may also be interested in the topics ‘The 10 best investments’ or ‘Best investments at the moment’. Find out more here.
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