Compound interest – the money superpower

If there’s one money concept to make sure you understand as early as you can, it’s compound interest. Compound interest is what makes money grow – and the more time you give it to grow, the more it will work for you. Let your money make money.

When you save, you earn interest* on your savings. The higher the interest rate, the more interest you earn. Over time, you will keep earning interest on your original savings, and you will also start to earn interest on the interest you’ve just earned (as long as you don’t withdraw it). This is known as compounding.

The growth may not seem like much at first but, given enough time, these repeated cycles of growth on growth make incredible things happen. Like a snowball rolling down a hill, gathering speed and increasing in size, your savings pot will grow the longer you leave it alone.

When you start matters more than how much you save Consider the following examples of the impact of time on your money:

Qondiswa invests R500 per month in an account earning 10% interest, compounding annually. She begins at age 18. At age 28, she stops. She has invested a total of R60 000 over the 10 years. She never contributes again. She doesn’t withdraw any money from the account until she is 65, staying invested for a total of 47 years.

Hlomla invests the same R500 per month, in an account earning 10% interest, compounding annually. He begins where Qondiswa left off. He begins investing at age 28 and continues the monthly R500 investment until he retires at age 65. Hlomla has invested for 37 years, contributing a total of R222 000. Even though Hlomla has contributed nearly 4 times as much as Qondiswa did, she has still reached retirement with slightly more money than he has, simply because she started saving 10 years sooner than he did.

As a final example, consider Nicky. She invests R500 per month in an account earning 10% interest, compounding annually. She begins at age 18 and continues investing until retirement at age 65. She has invested for 47 years and contributed a total of R282 000. Although she has contributed only R60 000 more than Hlomla, she can retire with R1 million more than he does, simply because she started saving 10 years sooner.

The moral of the story? If you start early enough, time will contribute more to your savings than you ever could. So start building a savings habit now – even if it’s just to build an emergency fund. Once you graduate, prioritise saving and investing from your very first pay cheque. Don’t worry if it’s only a small amount at first – you have time on your side to do all the heavy lifting for you.

MONEY TERMS There are a lot of technical terms when we talk about money. Don’t let it intimidate you; it’s really not all that complicated. Here are some explanations for common terms:

South African Reserve Bank
The South African Reserve Bank is the central bank of the Republic of South Africa. The primary purpose of the Bank is to achieve and maintain price stability in the interest of balanced and sustainable economic growth in South Africa. *

Interest
Interest is essentially a fee. You can either pay interest in return for the benefit of borrowing money, or you can earn interest when you save or invest money. Interest is what allows your money to make money for you. It’s also what makes debt an expensive way to use money.

Repo rate
The repo rate is the interest rate commercial banks pay to borrow money from the Reserve Bank.

Inflation
Inflation is the rate at which the general price of goods and services rises in an economy over time. Over time, inflation decreases the purchasing power of your money, meaning that you will be able to buy less with R20 a year from now than you can today. Ask your parents how much a loaf of bread or a packet of chips cost when they were kids, and you’ll have a clear example of what inflation does to prices.