Make money work for you

The 8th wonder of the world is the compounding effect of interest. This compounding effect is the foundation for long term financial success.

How does it work? Let’s say you have $10,000 to invest. Let’s call this your “capital”.

If in the first year you earn 7.5% on your capital, the total at the end of that year will be $10,750. If you keep the earnings and only invest the same $10,000 in the 2nd and subsequent years you will have $13,750 after 5 years. Not bad?

Instead of withdrawing the earnings from the first year you decide to reinvest it for the 2nd year. This is called compounding the interest. At the end of the second year you have $11,556. If you continue this process of reinvesting your interest capital and earnings every year, after 5 years you will have saved $14,356.

You will have earned interest on your interest and that is the wonder of compounding returns.

These mystical effects are enhanced with additional contributions to capital. Say you contribute $200 per month and reinvest your earnings each year. Your new total after 5 years is $21,772. Initially, your capital grows more from your contributions than its earnings. But as you go along your reinvested capital grows to a point where your earnings can exceed the contributions and your savings accelerate.

Now imagine you take this principle and apply it to a long period of saving – starting with $10,000 and contributing $200 per month and compound the earnings. After a 30 year working life you will have accumulated $316,596.

Smart money strategies often involve planning to make small contributions over a period of time. Contributions are made into investments that have low costs and are tax efficient. Saving for a home deposit or a new car is easy with the magic of compounding interest.

Consult the Reach your savings target calculator to see what you can save.