You will have heard how powerful compound interest is at building wealth but how do you calculate the future value of a savings account of, for example R10 000/year over 40 years if you reinvest the interest every month?
Compound interest is an incredibly powerful force in retirement savings, in fact, it’s one of the most important tools you have in your in vesting and savings arsenal when it comes to building a retirement portfolio that will allow you to retire with complete peace of mind.
Compound interest is the interest earned on the capital of an investment, as well as on any previously accrued interest. This means that over time, your interest earnings can grow exponentially as you reinvest them back into your portfolio. The longer you let your interest accrue, the more powerful the effect becomes.
Investing for retirement is all about consistently investing over a long period of time. Any market analyst will show you that over time the markets are always on an upward trajectory, the key is not to fear the short term downturns but to keep investing every month at the same level to achieve a long term positive outcome. This is exactly how compound interest works, long term investing of your capital and interest which then compounds into a very nice return over time.
Time is your greatest ally when investing and the smart money says to start investing from your first paycheck and keep investing every single month from that day onward. The longer you have to invest, the more time your money has to grow and compound.
Investing Scenario
Let’s say you start investing R10,000 per year in a retirement account at age 25. Thats is less than R1000/month. Lets assume an annual return of 8% which is a money market account or similar at most banks these days.
When you get to 65, your investment will have grown to a little over R3 000 000.
If you had started investing just five years later, at age 30, your investment would only be worth around $2 080 000. That’s a difference of over R1 000 000 by starting just 5 years later.
The power of compound interest is especially evident when you consider the effects of compounding over time. Let’s say you invest that same R10 000 per year at age 25, but instead of investing for 40 years, you invest for 50 years. Assuming the same 8% annual return, your investment will have grown to over R9 000,000 by the time you reach age 75. That’s almost three times as much as if you had invested for just 40 years.
It really is as simple as that. Start early, invest consistently, capitalise the interest and you will reap the incredible rewards of the “power of compound interest”. Now imagine you invested in a portfolio of stocks that showed a higher return over long periods! It all depends on what your attitude towards risk is. You can of course diversify your portfolio by having a conservative savings investment like the example above and then to invest into a different type of fund that has a higher risk profile but over time will again offer higher potential returns. It is always the right thing to do to consult a financial advisor to help you prepare for retirement and optimize your investmkent portfolio but be sure that the fees are not exorbitant. Fees can have a significant impact on your returns.
By allowing your interest earnings to compound over time, you can significantly grow the value of your retirement portfolio. The key is to start investing as early as possible and to give your money as much time as possible to grow and compound. So if you haven’t already started investing for retirement, now is the time to get started. Your future self will thank you.
Future value equation
Here are the equations that will help you calculate the future value of your investment strategy.
Example 1
You Invest R10 000 per year for 40 years at an annual return of 8%
Assuming annual contributions of R10 000 and an annual return of 8%, the value of the investment after 40 years can be calculated using the following formula:
Equation
FV = P * (((1 + r) ^ n) – 1) / r
FV = future value
P = periodic contribution (in this case, R10 000 per year)
r = annual interest rate (as a decimal, so 8% = 0.08)
n = number of periods (in this case, 40 years)
Using these values, the future value of the investment can be calculated as follows:
FV = R10 000 * (((1 + 0.08) ^ 40) – 1) / 0.08 = R3 015 055.62
Example 2
Investing R1,000 per year for 50 years at an annual return of 8%
Using the same formula as above, the future value of the investment can be calculated for 50 years as follows:
FV = R10,000 * (((1 + 0.08) ^ 50) – 1) / 0.08 = R6 665 733.81
As you can see, the power of compound interest is evident when you compare the future values of the two investments. By investing for an extra 10 years, the future value of the investment more than doubled. This is why it’s so important to start investing for retirement as early as possible and to give your money as much time as possible to grow and compound.
Photo by Edward Howell
