To quote Albert Einstein on compound interest: “It is the greatest mathematical discovery of all time.” In the financial world it is, without doubt, considered the eighth wonder of the world and, because of the time value of money, compound interest will always remain a true wonder.
Where money is concerned there are often unwritten rules which, provided we heed them, will allow us to reap the rewards. One of these rules is that you cannot compensate for, or replace the loss of, compound growth in later years. During my many lectures to student groups I always place great emphasis on compound interest and the fact that one can never be too young to begin saving, in order to reap the benefits of this interest.
The early bird catches the worm
Put simply, this growth mechanism of compounding adds interest to your capital from the moment you invest it and, thereafter, the powerful multiplying effect results in interest being earned on interest.
To highlight this, I use an example of R200 invested to age 65, which will escalate by 8% per annum (this means that in the 13th month the premium will increase from R200 to R216, in the 25th month from R216 to R233,28 and so on). I have also assumed that the fund will achieve a growth of 10%. In the table above you will see the illustrative values.
It is quite frightening to see the difference that five years makes. By starting at the age of 35 rather than 30, you will have invested only R14 079 less but the value will be reduced by R828 368 over the remaining period of the investment. You are probably shaking your head in disbelief. This is the power of compound interest.
It is very difficult to create wealth without employing this compounding effect and, hopefully, this example with encourage saving as soon as possible.
Starting Age | Value |
30 | R1 830 662 |
35 | R1 002 294 |
40 | R534 072 |
45 | R273 484 |
Retirement planning
We see the benefits of compound interest feature especially in the area of retirement planning. By not harnessing the power of compound interest in retirement planning, the difference a year or two can make can be detrimental to your retirement savings. As a result of losing out on a couple of years of compound interest, many may actually have to delay retirement in order to make up for this “lost” time.
Time is the most powerful asset when it comes to investing. The earlier you start investing, the more time you leave for the miracle of compound interest to take effect. The true glory of compound interest only shows with time. Set realistic goals and make a detailed plan of how to get there.
We always hear the phrase ‘time is money’. Well, when it comes to investing, time literally is money. By beginning to save as soon as possible you will increase the future value of your money by investing and gaining interest over a longer period of time.
At the end of the day, my advice to all investors is to exercise patience, weather the storms of volatility and reap the benefit of the eighth wonder of the world, namely the awesome power of compound interest.