Compounding is the process of generating earnings on an asset’s reinvested earnings. To work, it requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment, which takes the pressure off you.
Why it is better to start early
Consider two individuals, we’ll name them Peter and Paul. Both Peter and Paul are the same age. When Peter was 25 he invested R15,000 at an interest rate of 5.5%. For simplicity, let’s assume the interest rate was compounded annually. By the time Peter reaches 50, he will have R57,200.89 (R15,000 x [1.055^25]) in his bank account.
Peter’s friend, Paul, did not start investing until he reached age 35. At that time, he invested R15,000 at the same interest rate of 5.5% compounded annually. By the time Paul reaches age 50, he will have R33,487.15 (R15,000 x [1.055^15]) in his bank account.
What happened? Both Peter and Paul are 50 years old, but Peter has R23,713.74 (R57,200.89 – R33,487.15) more in his savings account than Paul, even though he invested the same amount of money! By giving his investment more time to grow, Peter earned a total of R42,200.89 in interest and Paul earned only R18,487.15.
Written by Karen van Rooyen
Tags: compound interest, retirement, saving
This post was written by thys