How to help grow your money through compound interest

Title
Compound interest
Short description

Compound interest enables you to earn interest on interest which is accumulated over time. We look at how you can make the most of compound interest.

Topics
mlc:Topics/investments
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false
Time to read/watch
4 min
Effective date
2024-08-30 00:00
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Compound interest – help your money grow

Einstein has repeatedly said that compound interest is the eighth wonder of the world.

While it may appear complicated, it's actually a relatively simple concept that can accomplish extraordinary things over time.
 

What is compound interest?

Compound interest enables you to earn interest on interest which is accumulated over time.

Metaphorically speaking, it's like planting a tree. When that tree grows, it produces seeds that allows you to plant other trees. Those trees will also grow and produce seeds of their own. So with enough time, you could turn one tree into an entire forest.
 

Difference between compound interest and simple interest

When it comes to earning interest, or a return on your money there are two types of interest you could earn.

Compound interest enables you to earn interest when you invest a sum of money. But in addition to this interest, you'll also earn interest on the interest you've earned.

With simple interest however, you'll only earn interest on your original sum of money invested.

For instance, if you invest $10,000 into a savings account and earn 5% interest compounded annually, in the first year your interest earnings will be $500 (5% x $10,000). However, in the second year, your interest will be calculated based on the original amount you invested, plus the interest you earned in the first year - $10,500. In total over 3 years, you would have earned $1,576.25 in interest.

With simple interest, your interest earnings won't increase year on year so you'll continue earning just $500 over the 3 year period leaving you with $1500 in interest earning.

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Compound interest is a long-term investing strategy

The effect of compound interest becomes extremely powerful over a long timeframe as the amount of interest earned grows.

Warren Buffett is the epitome of someone who values long-term investing. He attributes the majority of his success to identifying good businesses and companies with strong fundamentals to buy and hold for the long-term.1 He then let the magic of compound interest work for him.

One thing that is important to remember is that investing in the beginning doesn't reap many rewards. It isn't until years later that you feel the true power of compound interest working for you.
 

Get started early with compound interest

Because compound interest is generally most effective over a long timeframe, in order to truly see its potential, the earlier you start investing your money, the better. So it's generally really not about how much you’re investing, but more about how much time you're allowing your money to grow when it comes to compound interest.
 

How you can earn compound interest

Bank account

One way to earn compound interest is through a bank account. While this approach carries very little risk, it's generally unlikely that your returns will be enough to outpace inflation so this is something to keep in mind.

Super

Investing in your super is one of the most effective ways to potentially maximise the benefits of compound interest.

Why? Time is on your side. The more you contribute to your super early on in life, the higher potential for that money to grow by the time you need it as a result of compound interest. Of course though, you need to bear in mind that you cannot access your super until you meet a condition of release. This includes reaching the legal age for retirement, among other things.

Dividends

When you're paid dividends from shares, you can withdraw that dividend as cash or you can reinvest it back into the issuing stock. This means you're earning dividends on dividends, also known as compound interest.

Bottom line: When it comes to investing, compound interest and time are truly your best friends.

1 http://www.arborinvestmentplanner.com/warren-buffett-strategy-long-term-value-investing/

 

Are you on track for retirement?

Use these calculators to see how much you'll need—and how close you are to reaching your goals.

 

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Related links

6 things to consider before investing

Choosing how your super’s invested

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  • This article has been prepared by NULIS Nominees (Australia) Limited ABN 80 008 515 633 AFSL 236465 (NULIS) as trustee of the MLC Super Fund ABN 70 732 426 024. NULIS is part of the Insignia Financial group of companies comprising Insignia Financial Ltd ABN 49 100 103 722 and its related bodies corporate (‘Insignia Financial Group’). The information in this article is current as at June 2024 and may be subject to change. This information may constitute general advice. The information in this article is general in nature and does not take into account your personal objectives, financial situation or needs. You should consider obtaining independent advice before making any financial decisions based on this information. It is recommended that you consider the relevant Product Disclosure Statement (PDS) and Target Market Determination (TMD) before you make any decisions about your superannuation. You can obtain the latest copy of the PDS (or other disclosure documents) and TMD by calling us on 132 652 or by searching for the applicable product at mlc.com.au. You should not rely on this article to determine your personal tax obligations. Please consult a registered tax agent for this purpose. Opinions constitute our judgement at the time of issue. The case study examples (if any) provided in this article have been included for illustrative purposes only and should not be relied upon for decision making. Subject to terms implied by law and which cannot be excluded, neither NULIS nor any member of the Insignia Financial Group accept responsibility for any loss or liability incurred by you in respect of any error, omission or misrepresentation in the information in this communication.