The Magic of Compound Interest

The most powerful tool in the financial world is that of compounding. It is a phenomenon which even amazed Albert Einstein who was said to call it the 8th Wonder of the World.







So what is it all about?
Essentially compounding is reinvesting the returns you make on an investment back into the investment.

For example:
You invest R500 in a unit trust fund which makes 10% in a year amounting to R50. Buying more units in the investment for the R50 starts the next year with R550. The following year the same 10% return is now made on a larger amount and the result at the end of the year is now R55. By reinvesting the 3rd year starts with R605 which returns R60,50 at the end of the year.

Consistent positive returns
So the way to maximise your savings is to save for the longest time possible in investments that consistently give high positive returns and then reinvest these back into the investments, creating the magical compounding effect over the period.

Time is needed
The longer you save the greater the effect. The same R500 in our example got to R605 over 3 years. If you continued over 10 years you get to R100 728 and over 20 years R361 993.

Be mindful of inflation
You need to beat inflation. The value of money into the future depreciates against the rise of the cost of living. This is called inflation. To keep the value of your investment real you need to achieve returns above the inflation rate. So, investments that achieve more than 6% (which is the current rate) will compound over time to provide real value which improves your wealth.

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