The beauty of compound interest


Spending time in the market gives you the benefit of compounded returns on your investment. We are often asked questions such as “When would be the best time for me to start investing?”  “Should I wait until there is more certainty in the economy?” “Should I wait until the political situation in the country becomes more stable?”

The longer you take to decide whether or not to invest, the more you will miss out on the powerful force known as compounding. The beauty of compounding is that it is available to everyone, and it can have an exponential effect on the value of your investment over time. Albert Einstein is believed to have referred to compound interest as the Eighth Wonder of the World, stating that “he who understands it, earns it, he who does not, pays it.”  Warren Buffett, one of the most successful investors of all time, attributes the effect of compound interest to being the single most powerful factor behind his success.

Compounding occurs when the returns produced by an investment are reinvested to generate interest on interest. An initial investment earns interest which is reinvested, and the greater amount again earns interest, over and over again. The benefit of compound interest and starting to invest as soon as possible can best be illustrated by an example. If you were to invest R1,000 a month from age 25 to age 35 and then stop investing, you will have an investment worth approximately R2 million at age 65, assuming an 8% annual return.

However, if you delay starting to invest and only begin investing R 1,000 per month when you turn 35 and continue investing for 30 years to age 65, your investment would only grow to around R1.5 million. This is substantially less than had you started earlier and invested for a shorter period of time. The more time you spend in the market, instead of trying to time the market, the higher the ultimate value of your investment is likely to be.
In this world of instant gratification, many investors become impatient with short-term returns and do not remain invested long enough to allow the real power of compounding to take effect.

Compounding requires time and patience and investors who invest for the long-term reap the rewards which are available to them.

It is never too early or too late to start investing, but there is no doubt that the younger you are when you start, the more you will benefit from the miracle of compounding. Once you have made your decision to invest, it is essential to do so using products that are suitable for your needs. Not all financial products are the same; each has its own associated level of risk, potential return, tax benefit and cost structure. Just as the effect of compounding can generate significant positive benefits for your investment, so too can excessive costs or unnecessary fees have a negative effect on the final outcome.

A Certified Financial Planner® will be able to explain the various options available and assist you make an informed decision that will enable you to achieve your long term financial goal.

  • Rands and Sense is a monthly column, written by Ross Marriner, a CERTIFIED FINANCIAL PLANNER® with PSG Wealth. His Financial Planning Office number is 046 622 2891
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