How compound interest works
If you save $100 at 10% interest, after a year you have $110. The next year, your $100 earns another $10 – and the first $10 of interest also earns $1 interest of its own. So your balance grows to $121, not $120. The extra might not seem like much at first, but after three years you’ll have $133. And so on, until after 10 years your $100 has become $259 – which is $159 just from compound interest.
Compounding works for all types of investment returns, not just interest on savings in the bank. So you can have compound returns as well as compound interest.
The earlier you start, the more your money grows
Let’s say you invest $2000 each year (into an aggressive investment fund of mostly shares, earning the same average annual return of 5.5%). If you start at age 18 and stopped at 41 you’d see your money grow seven times to $362,562 at age 65.
If you instead wait until age 42 to start investing, you’d still have invested $48,000 over 23 years. But you would end up only doubling your money to $100,305 by age 65.
Use compound returns to keep ahead of inflation
Do you remember when you could get a big block of cheese for just $8? Or maybe your parents or grandparents talk about how cheap things used to be? Prices tend to increase, and they’ve gone up a fair bit through the years.
As prices inflate and things get more expensive – whether it’s food, petrol, housing or cars – our money buys less and less. That’s inflation.
Although we may have cash stashed away, it’s losing value all the time, like sand slipping through our fingers. This can make it challenging to save for long-term goals.
How can we build up enough to stay ahead of inflation?
One way is to invest so our money grows through compound returns. Ideally we want the rate of return to be higher than the rate of inflation.
Take advantage of compound returns for your long-term goals
Investing is the way to make the most of your money and reach your long-term goals – things that are 10 years or more in the future.
If you’d like to give this a go, check out our guide to help you get started, and our tool to work out your investor profile.
If you’re in KiwiSaver, you’re already an investor. The money we put in is invested in assets (types of investments like shares and property) managed by professionals, and the returns compound each year. This is why it works so well for long-term goals such as retirement or buying your first home.
The benefits of compounding also continue during retirement on the money you don’t withdraw straight away, helping make your money last longer.
To get an idea of what you are on track to achieve in KiwiSaver in the run up to retirement, or to see how long your money will last once you’ve stopped working, try our KiwiSaver calculator.