The Tale Of Compounding Interest
1st of March, 2021
“Compound interest is the eighth wonder of the world. They who understands it, earn it…those who don’t…pay it.” – Albert Einstein
We have probably all heard about compounding and how important it is, but how does this all play out in a real life example?
Let me introduce you to Nikki, when she was 21 years old, she finished university and became a qualified accountant. She landed a job and started working full time at an accounting firm in the city. To cut down her commute and explore a different lifestyle she decided to move out of home and with that took on a lot more outgoing expenses; Sunday brunch doesn’t pay for itself after all. When Nikki decided to move she also committed to start saving and to invest some of her surplus cash. She opted to put aside just under $50 a week so that at the end of the year she had saved $2,500. She put this aside and invested it every year until she was 30. The investment she choose returned on average 7% per annum.
When Nikki turned 30 she had a baby (a little boy Jack for those wondering), she left her investment to grow, but needed that $2,500 she had been contributing each year to put towards her growing family.
Nikki’s twin brother Adam is a landscape architect. He too lives near the city and while he saved some money in his 20’s he used a lot of it to fund holidays, sporting events and didn’t think much about investing.
When he turned 31 he decided it was time to build his future and started to invest. He contributed $2,500pa toward the same investment as his sister returning on average 7%pa, he continued to do this until he was 65.
Let’s review the math here:
Nikki contributed $2,500 between the ages 21 to 30, in total she contributed $25,000.
Adam contribute $2,500 between the ages 31 to 65, in total he contributed $87,5000.
They each put their savings into the same investment which returns on average 7%pa.
So by the age of 65 where do they each sit?
Nikki’s investment would be sitting at $394,500 and Adam’s at $369,700.
Given the difference in the amount that they have each contributed over time, it is the effect of compound interest which gives Nikki the higher balance.
The “eighth wonder of the world!” Compound Interest!!
Now these numbers have been rounded but the point remains, compound interest matters and those who “understand it earn it…those who don’t…pay it.”
Please pass this knowledge on, you could be doing someone a world of good.