It may have taken a brilliant mathematician, such as Albert Einstein, to declare that “compound interest is the eighth wonder of the world’’ but it took a brilliant investor, Warren Buffett, to prove the theory in all its wonderful glory.
Mr Buffett, one of the canniest investors around, explained that his “wealth has come from a combination of living in America, some lucky genes and compound interest”. (1)
While many of us cannot rely on living in the US nor be born with gold-plated DNA, we can aspire to growing our wealth using compound interest.
It works by adding to your savings with regular interest payments that merge with the original deposit, so the next time interest is paid, it is on the total sum – the original deposit plus previously earned interest. This pattern continues and compounds as long as withdrawals are avoided.
For instance, $2,000 invested at 5 per cent will be worth $2,100 a year later. Keep the deposit intact and the following year that $2,100 earns another 5 per cent and grows to $2,205. After 15 years, the compounding interest has doubled your money to more than $4,150.(2)
Adding deposits over time turbo charges compound interest
Naturally, the greater the rate of interest you are paid, the bigger the multiples of compounded value over time. If you are lucky enough to attract 10 per cent interest, a $2,000 deposit would more than quadruple to $8,354 after 15 years.
Currently, in these times of Reserve Bank of Australia induced low interest rates,(3) a standard savings account is unlikely to deliver enough income to keep deposits ahead of inflation.
However, as your financial planner, we can advise you on other types of savings strategies with greater compounding qualities to fulfil your future wealth ambitions.
With the right investment, a 30-year-old putting $1,000 away at 8 per cent interest could collect more than $14,000 on retirement without ever having added to the original deposit.
Even at half that interest rate, making an initial deposit of $1,000 on the birth of a baby and then $20 a week thereafter would, with compounding interest of just 4 per cent, deliver almost $30,000 by the time the child is 18 – enough to buy a car.
That is the wonder of compounding interest – the ability to effortlessly multiply savings over time. If you have a savings target in mind, speak to your financial adviser to help you put the right building blocks in place.
This information is provided by Charter Financial Planning Limited (Charter FP) ABN 35 002 976 294, an Australian Financial Services Licensee, Licence No. 234665, a wholly owned subsidiary of AMP and a member of the AMP Group. It is believed to be correct at the time of publication, however, no representation or warranty is given as to its accuracy. No liability is accepted by any company within AMP or their respective employees or directors for any statement or opinion or any error or omission or for any loss arising from reliance on the information contained in this document. Investments may only proceed by completing the relevant application form attached to a current Product Disclosure Statement (PDS). Fund managers will receive fees for their services out of which authorised representatives of Charter FP may be paid commission. Neither the return of capital nor the investment performance of any investment is guaranteed by Charter FP. Past performance is not indicative of future performance. Any advice given in this document has not been prepared taking into account your particular investment objectives, financial situation or needs. Any case studies in this publication are hypothetical are not meant to illustrate the circumstances of any particular individual. You should assess your particular investment circumstances prior to making any financial decisions. This taxation information is based on the continuation of present laws and their interpretation and is a general statement only. Individual circumstances may vary. From time to time we may bring to your attention products, services and other information that may be relevant to you. If at any time you no longer wish to receive information, you may opt out by contacting our office.