COMPOUND INTEREST

Albert Einstein once famously said: "Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it."

Einstein couldn't have put it better. Compound interest truly is one of the most powerful forces in the universe, and it can both work for you in the case of growing investments or against you in the case of compounding debt. The key ingredient for compounding growth is time.

That said, few people truly take advantage of this financial tool to its fullest.

Retirement annuities (RA) are built on this concept, so knowing that time is the key ingredient, why do so many people start an RA so late?

By starting an RA early, you get the full benefit of time. An idea for new parents or parents of small children is to take our an RA for them when they are born. It can be started with a lump sum with or without monthly contributions. This is an ideal way to guarantee your child’s future financial security without it costing you a fortune. They get an additional 20 years of savings under their belt before they even begin working. This can be gifted to the child when they start working and they can then grow and add their own contributions. The upside is that this has real value but cannot be accessed until the age of 56 (current legislation) or at retirement; so, there is no concern that your child will squander all the savings on a holiday or luxury items.

Additional benefits are that contributions can be added as lump sums, increased or decreased and even stopped. The interest will continue to accumulate and the investment will continue to grow, even without contributions.

When the policy is handed to your now grown child, they can contribute and receive a tax refund on their contributions going forward.

If you were to invest a sum of just R1000 at the time of their birth and R250 per month thereafter, escalating at 10% per annum and they continued with the same strategy until they retired at the age of 65, they would have an approximate retirement fund of R44,478,909.20 based on annual growth of 7%. Alternatively, if you stopped at age 21, the sum would be R347,527.81. If this sum was never added to and just left to mature to age 65, it would total about R7.5M at retirement.

Lastly if you do the deposit and keep the monthly contributions at R250 per month for the full 65 years, the total would be about R4,052,946.18.

The downside of this investment is that it is locked in till retirement and cannot be withdrawn, but future security is the name of the game.

By showing the investment to children, explaining how it works and the benefits of saving, you can instill knowledge and passion for saving and financial awareness that seems to have been neglected in education today.

In years gone by, children were taught the importance of saving about 10% of their earnings monthly. The culture of saving rather than spending needs to be reawakened to help future generations to secure their future.

All investments use compound interest and interest rates fluctuate so it is vitally important that you communicate with your financial adviser or broker regularly.

They can advise, but only you can authorise changes to your portfolio. Investment is not a passive endeavour, you need to be an active participant to get the most out of your savings.

1. Anyone can benefit from compound interest. There’s no need to be a Wall

Street wizard or a Harvard MBA.

Almost any investment will earn compound interest if you leave earnings in the account.

2. Compound interest is a double-edged sword. It's great if you're routinely saving money, but it can be cruel if you're borrowing money.

3. You want savings to compound as often as possible. It's better if you compound quarterly rather than annually when you're saving money.

If you're borrowing, just the opposite applies.

4. Time is on your side. The longer money compounds, the faster it grows. Money growing at 6 percent per year will double in about 12 years, but it will be worth four times as much in 24 years.

5. Time is not on your side. Credit cards and other open-ended accounts use compound interest against you.

That's why “minimum payments” are likely to keep you in debt forever.

6. Don't let low interest rates discourage you. It's true that banks aren't paying much on savings accounts. But many investments average a higher return and have very low minimums and no monthly charges. If you can't apply a few Rand to savings, most debts (think mortgage or credit cards) will allow you to add any amount to your payment.

7. It adds up faster than you think. If you were to save R5 per month, you’d earn 5 percent interest compounded each month and with that continually for 10 years you'd have put R600 into savings. But the account would be worth R776. And, even if you didn't add a single dime, it would be worth more than R1,500 in another 15 years. Obviously the more you save, the more you earn.

8. Compound interest can free you from credit cards. Suppose your interest rate is 14 percent and you add just

R5 per month to your payment. In 10 years, you'll avoid R1,315 in payments.

9. You don't have to be rich to make compound interest work for you. The principal works the same whether you invested R100 or R100 million.

The millionaire may have more investment options, but even the poorest among us can use compound interest to reduce the amount that we pay credit-card companies.

10. Compound interest requires you to sacrifice today to reap a benefit tomorrow. It's true that you'll need to do something to save a few dollars today. But it's certain that the future reward will be greater than the sacrifice. �