Time is on your side: The power of compound interest

Taking advantage of the power of time and compound interest is one of the basic building blocks in developing an effective regular investment plan.

Compound interest simply means re-investing all the interest you earn each month. In this way, you can earn interest on your interest, as well as on your capital. As a result, your savings grow much faster.

Consider a savings plan where you invest an initial sum of $500 and then $100 each month for 30 years. This equates to a total investment of $36,500, but the final value will be around $86,000 if the earning rate is 5% after tax.

If your savings achieved an annual earnings rate of 7% after tax, the $36,500 invested would be worth over $121,000 at the end of the thirty years…mainly because the investment earnings have been compounded (or reinvested), thus increasing the rate at which the savings grow. (To achieve the higher earnings rate, a diversified portfolio should be used.)

Obviously the longer you let your investment go on earning for you, the greater your reward will be in the end. However, you don’t have to be invested a long time for the benefits to show up.

To get compound interest working as efficiently as possible for you, and to ensure the savings involved actually happen, it is helpful to make the payments into your chosen investment on a regular basis.

Many people opt to do this automatically, having an amount deducted each pay or each month and credited to their investment plan. Regular payments, as well as being convenient, give compounding its best chance to work for you.

By Judi Galpin – DecisionMakers (Manawatu) Limited