American playwright, Tennessee Williams was right on the money when he said that “you can be young without money but you can’t be old without it” so the question is: why aren’t more people taking advantage of compound interest when saving while they’re still young?
For the uninitiated, compound interest is basically earning money on an ever-increasing amount – below is a table showing how compound interest works:
|YEAR||INVESTED AMOUNT||INTEREST||END OF YEAR AMOUNT|
|0||R1 000||R1 000 × 10% = R100||R1 100|
|1||R1 100||R1 100 × 10% = R110||R1 210|
|2||R1 210||R1 210 × 10% = R121||R1 331|
|3||R1 331||R1 331 × 10% = R133||R1 464|
|4||R1 464||R1 464 × 10% = R146||R1 610|
- Calculate the Interest (= “Investment at Start” × Interest Rate)
- Add the Interest to the “Investment at Start” to get the “Investment at End” of the year
- The “Investment at End” of the year is the “Investment at Start” of the next year
Compound interest is especially powerful when it works for you over an extended period. If we took the above example and looked at year 10, the amount at the end of the year would be R2852.21 where if you invested your R1 000 in a simple interest account, you will receive back R2 000. Simple Interest = P x I x N (R1 000 x 10% x 10)
- P is the Rand amount
- I is the interest rate
- N is the duration of the loan, using number of periods
Saving should be an important part of your financial plan as it can easily govern the big purchases made during your working years, as well as your standard of living once you retire. There are essentially three types of savings:
The experts tell us that you need at least six months of your salary saved up in an emergency fund in case something happens to you, e.g. you are retrenched or unable to work for a certain length of time. Then there is short-term savings that you use to save towards a specific goal such as new furniture, a holiday or even a deposit on a car.
While emergency savings and life, dread disease and disability cover take care of any risks that may affect you during your income earning years, long-term savings or investing make up a substantial part of your “retirement package”. Investing is the process of putting a larger amount of money into money-making assets such as money markets or stocks and leaving it there to accumulate. This investment along with your retirement annuity and pension fund should allow you to enjoy your golden years without having to worry.
Before investing money for either long term or short term goals, it is important to get advice from either your bank or a financial planner as to what the best options are for you in terms of what you ultimately want to achieve. Some investments give high returns but can be risky, while other more stable opportunities may take longer to yield any returns – your goals and risk profile, will determine what kind of investment and savings you need to make.