Saving money the compound interest advantage

Cape Town - You've probably heard the term before: compound interest. But do you really understand how this works?

Compound interest is what allows a very average saver to become a wealthy individual. What's the secret? The value of compound interest is not in saving vast amounts – instead, it's all about when you start saving.
According to Danelle van Heerde, head: advice processes and tools at Sanlam Personal Finance, it is important to understand the basic principle of compound interest.

Piggy Bank

"It's effectively earning interest on interest on interest. So, once you have put your savings aside, however insignificant it may seem, you do not have to do anything, bar watch your money increase.
"It's the best way for your money to grow over the long term."

Van Heerde shows the strength of compound interest by taking a saving of just R250 per month. "For many savers, R250 amounts to a single trip to your local store to stock up on groceries."

Put another way; imagine taking just R8 out of your purse daily, and setting it aside.
How does compound interest work?

If you save R250 a month between the ages of 24 and 30, you will, according to Van Heerde's calculation, have accumulated more at age 65 than someone who saves the same amount monthly from age 35 to 65.

In the first example, you have actively put away R250 for six years, or 72 months, amounting to R18 000 without interest. In the second, you've actively saved R250 for 30 years, or 360 months, worth R90 000.
And somehow you will still have more at age 65.

It works like this:

- If you put R250 away monthly between 24 and 30, and then leave those savings in your account, you'll be worth R479 453 by age 65.

This is based on an interest rate of 9% (Van Heerde says this is calculated assuming 6% inflationary returns, plus 5% real returns, with 2% subtracted for fees).

- On the flip side, put away R250 between 35 and 65, and you'll only end up with R425 528. "The difference is in the extra amount of time that your savings have to earn interest or compound, starting at age 24 instead of 35," she says.

How can it benefit you if you'd like to save for your children's education?

This lesson is an important one for parents in particular. School and university fees are becoming increasingly burdensome on parents – but making use of compound interest is a great way to reduce this load.

Source fin 24
Tags : saving money, compound interest, sa saving money, finacial freedom