The Power of Compound Interest

Many Individuals are unfortunately ill-prepared for retirement, and it’s an unsettling prospect that so many citizens of this modern day world may not be able to support themselves in their golden years.

However, the beauty of compound interest means that if you start saving from an early age, investing in your future doesn’t have to be the heavy financial burden that many people fear (and thus postpone). The power of compound interest actually makes saving from an early age much cheaper and less stressful than if you were to put off saving until you’re older.

Albert Einstein referred to compound interest as “the greatest mathematical discovery of all time”, and he declared it to be “the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it”.

This is best illustrated by means of an example:

Based on a growth rate of 10% per annum, if one saves €1,000 a month, the capital amount after 20 years would be €759,300. If one saves €1,000 per month for 40 years, the value would be €6.3 million… The total contributions for the client who saved for 20 years was €240,000 and the contributions of the client who saved for 40 years was €480,000, yet the difference in their values at retirement was a massive €5.5 million.

This is because compound interest is the interest calculated on the initial principal, compounded with accumulated interest. It is essentially the result of reinvesting interest so that interest is then earned on the principal sum and previously-accumulated interest combined. To put it simply, it can be thought of as ‘interest on interest on interest,’ and it will make a sum grow at a faster rate than simple interest, which is calculated only on the principal amount.

The company that you work for may make monthly contributions to your retirement either in addition to your wage or through salary sacrifice. Accordingly, if you begin with your company retirement fund at age 25, then 19% of your salary should be sufficient should you continue with this for the next 40 years and not cash-in your funds on resignation or retrenchment, but rather preserve them. Should you start working later, then you would need to invest a higher percentage of your salary to compensate for your lack of compound growth in previous years.

Time is of the essence when it comes to taking advantage of the effects of compound interest to build a healthy savings pot that will provide for you in your autumn years, as well as potentially allow you to support your children with their financial goals. The bottom line is that the longer you wait to start saving, the more money you will need to save to achieve the same financial goal. And this is particularly the case when it comes to retirement savings, as this could benefit from a 40-year saving term.

The power of compound interest lies not in saving vast amounts, but instead when you start saving. Don’t underestimate its power, and don’t hesitate to arrange a meeting to find out how much you need to save per month to reach your retirement goals. Calculations will be based specifically on your current age, desired retirement age, and future requirements, so don’t delay in making compound interest work for you.

Please note that all figures in this post are average examples and don’t constitute financial advice. Each plan is unique and needs to be tailored inside of a host of influencing factors.

If you want to see how compound interest works in a real life situation, why not simply try my personally made compound interest calculator. To access this you can simply follow this link. What’s best though, is that it is FREE; and…I will not even ask you for your e-mail address. Simply download the editable Excel sheet and populate it as you wish. I am sure you will find the results rather impressive!

Want to see this calculator in action, watch my video here.

Published by

peterbuttonifa

After obtaining his law degree and Masters in Finance, Peter ventured into the personal financial planning industry in 2012. For 7 years Peter has been advising clients both within the Netherlands and internationally. Being praised by colleagues and clients alike for his aptitude in technical aspects, Peter adopts a very personal approach in dealing with all of his clients. His areas of specialisation include retirement planning, investments and British pension transfers (QROPS). In addition to his professional levels of service, Peter values continued professional development. As a result, Peter continues to obtain new qualifications which put him in good stride to assist clients with even the most challenging of situations. Being one of the few UK Level 4 qualified advisors currently in the Netherlands, as well as European regulated, Peter is well-suited to provide financial advice taking cross border issues into account.

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