Have you ever wondered why some people seem to be better off than others when they seem to have similar lives and consistently track income, families and lifestyle.
This is usually because they have better financial behaviors, and many of them take advantage of this powerful tool known as compound interest.
It’s so powerful that the story goes when Albert Einstein was once asked what mankind’s greatest invention was, he said, âCompound interest. “
If you compare compound interest to a horse, it is not a thoroughbred, it is more of a workhorse.
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And like all work horses, it needs to be considered, well fed, watered and trusted to do its job.
So, let’s look at the workhorse of the financial world.
Compound interest is a fairly simple concept – it’s when you earn interest on both the money you save and the interest you earn on that money. Every year you earn interest again on interest, so interest is actually interest.
Basically, it’s your money that works for you instead of your money.
American author, inventor and scientist Benjamin Franklin described it simply: âMoney makes money. And the money that the money brings brings in the money.
But compound interest can work against you as well as it does in your favor. If you are in debt, you could be paying compound interest on the money you borrow.
But let’s focus on the compound interest on your savings (now that you have your New Year’s resolutions and plan to save some more this year).
Here are four quick tips on how to save that year this year, so you can take advantage of compound interest.
Go over all of your income and expenses over the past three months and see if there is any waste that you can reduce to provide a surplus.
Take those surpluses you have now created and put them in another account to make sure you don’t spend them. And then transfer that amount every payday.
Decide what your priority is for those surpluses – maybe pay off your credit card, create an emergency peace of mind fund, put it in KiwiSaver if you’re saving for a house, or even a managed fund.
Try to be disciplined with these new funds and make sure that they are used for the purpose you have decided to meet your needs and goals.
Let’s take a look at the effect of compound interest on your savings.
Remember, the earlier you start saving, the more compound interest you will receive.
Your money is working for you – sounds good, doesn’t it?
I took these calculations from the Sorted.org.nz website: This example saves $ 10 per week from age 20. The results are based on an interest rate of 2.5% after tax and taking inflation into account.
If you started saving $ 10 a week at age 20, at age 60 you would have saved almost $ 15,000.
Compound interest does a lot of work in increasing your wealth.
I used $ 10 because most people could save $ 10 a week, but imagine if you increased that amount every year to align yourself with a raise in pay or a new job.
The impact on your savings and your assets could be significant.
Again, it comes down to good financial behavior.
Start when you’re young, and you could be prepared for life just by trimming. Even if you’re older, it’s never too late to reap the benefits of saving.
Compound interest is so simple, but it never comes to mind when we consider why saving is so important or how effective it can be in the long run.
In the words of my financial advisor – have a plan, revise the plan, stick to it, then enjoy.
Financial security and freedom can happen with just a few small changes.
Make a positive change for yourself in 2022. Save today.
Financial Advisor, New Zealand Managing Director, Katrina Shanks