The Power of Compound interest

“Compound Interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.” - Albert Einstein

Compound interest is the interest generated on interest. It is the interest calculated on the initial principal investment amount and also on the accumulated interest of previous period. It is the money force that is more powerful than any other.

Sam Beckbessinger give a comprehensive illustration in a form of a question from his book entitled Manage your money like a f*cking grown up. He asks, would you rather I gave you a million-rand cash, today, or gave you one cent that double for thirty days? I mean, they don’t even make one cent coins any more but let’s imagine they did.

Sounds like a million rand would be a better way, right? Nope, if you take one cent and double every day for a month, by the end of 30 days you would have R5,3 million. From one tiny little cent that double every day your money would grow just over five million rand within a month. The power of compound interest works almost in similar fashion.  

Let us look at the following example that demonstrate how compound interest work from Warren Ingram Book entitled Becoming your own financial advisor. Say you are very disciplined and you save your money aggressively, it will take you probably eight years to save your first R1 million.

This assumes that you are able to save R5 000 per month for eight years and you invest all your money in shares. Over the long term, shares grow at 15% per year, which is why someone saving R5 000 per month, or R60 000 per year, can have R1 million after eight years.

But if you continue to save aggressively, your second million will take only five years, and your third million will take only three years. This is because of the power of compounding growth – It is your greatest companion and will be the force that push you to attain your financial goals.

Let’s assume you are more aggressive and want to make your first million rand in about four to five years. You can achieve that goal if you invest R9 000 a month in shares at about 8% interest rate. If you continue to save aggressively with the same amount on a monthly basis, it will take about two and a half years make your second million and only one year to make the third million.  Again, this is because of the power of compound interest.

If you cannot afford R 9 000 a month or R5 000 a month, perhaps you are willing to invest R1 000 in Exchange Traded Funds (ETFs) through EasyEquities.com, and you increase your investment by 10% every year, within six years you will have R100 000 in your investment account. If you continue to invest at that rate, you will have your first million rand in 13 years.

To wait for this long takes patience and determination but the good news is that, once you reach that one million mark, it will take you only another five years to make your second million and only another three years to reach your third. The power of the compound interest works powerfully for you over the longer term.

Compound interest works even more wonders if you start your saving or investment journey as early as you possible can because the more money you have in your investment account or the more money you invest on a monthly basis, the more you will earn or benefit from the power of the compound interest.