October 26, 2022

The Power of Compounding

The Power of Compounding
“It is never too early, but it can be too late”

The above saying has never been truer when it comes to investing for a future financial goal, such as retirement. This is because the power of compounding enables your money to work for you and it will inevitably mean your financial goal will be achieved with ease. It’s no wonder Albert Einstein once said this mathematical concept is the eighth wonder of the world.

What is a Compound Interest?

Compound interest is the interest on a deposit that is calculated based on both the initial principal and the accumulated interest from previous periods. Put simply, it is the interest earned on your interest. When you make a return on your investment and reinvest it then your principal grows. As the years go by, the interest you earn keeps increasing because your principal is essentially bigger each year.

For example, if you put $1,000 into a retirement investment account and the initial deposit earns 5% and the end of year 1, you have $1,050. Then if you earn 5% on that new amount at the end of year 2, you’ll have $1,102.50 (5% on your initial investment amount plus 5% on the interest you’ve already earned). This continues so on and so forth and gradually increases year on year until you have a much larger sum than you would from just saving cash.

The graph below clearly illustrates the power of compound growth and starting early if your goal was to generate a million dollars. In each scenario the initial amount and the growth rate is the same, but the length of time varies. Only in the first scenario, over the course of 25 years, is the goal of a million dollars achieved with a realised interest amounting to over USD 700k.

Compound Interest Growth Example 1

The example above assumes that you have money already to get working for you. But the reality is not many people have a lump sum of $287,500 to invest. However, many people would like to have a million dollars. The question is how do you get there? The answer is never straight forward, but the power of compound growth certainly makes your goals more achievable.

In the graph below we can see 4 different scenarios with each one resulting in a final investment value of a million dollars. However, the less time you allow yourself to save, the more it will cost and the harder it will be. By starting 20 years earlier, you can reach the same goal and save yourself approximately USD 378,300, which equates to USD 18,915 per year.

Compound Interest Growth Example 2

Here at Melbourne Capital Group we fully understand that everyone’s goals, timeframe and capacity to save are different, and there is no such thing as one size fits all. We are committed to assessing every person individually and taking time to understand their individual circumstances. If you have a financial goal that you need to reach, no matter how big or small, then feel free to get in touch to discuss how we can help with the guidance and discipline to support you in your endeavours.

Managing your finances is more about managing your investments. Jake Mowson is an experienced financial planner with a long history of guiding internationally mobile clients through their financial journey and providing them with the blueprints they need based on their goals. Whether it's budgeting, planning for your child's education or your retirement, Jake and our team will be able to help you navigate life's most important financial decisions.

Please don’t hesitate to contact him today on +6012 234 5394 and jakemowson@melbournecapitalgroup.com or click here to sign up.

 

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