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Go from Savings Zero to Hero

8 August 2018

What if there was a secret weapon that can take you from average saver to wealthy individual?

Well, there is. Just harness the power of compound interest.

The value of compound interest is not in saving big amounts – it’s all about when you start saving. It’s important to understand this basic principle of compound interest. It’s effectively earning interest on interest on interest. So, once you’ve put your savings aside, however insignificant it may seem, you don’t have to do anything except watch your money grow over the long term.

How does compound interest work?

Let’s take a saving of only R250 per month. For many savers, R250 amounts to a single trip to your local store to stock up on groceries.

If you save R250 a month between the ages of 24 and 30, you will 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 a month for six years, amounting to R18 000 without interest. In the second, you’ve actively saved R250 a month for 30 years, 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 at age 65.

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

On the flip side, put away R250 every month 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.

How can this benefit you if you’d like to save for your children’s future?

School and university fees are becoming increasingly burdensome on parents – but making use of compound interest is a great way to reduce this load.

Here’s how you can do it:

By putting away just R250 a month for your child when he or she is between the ages of five and 10, and then leaving that money in the account, your child will have about R50 000 at age 20 – a great way to help pay the fees.

Or you can leave the money to earn more interest, and by 65 your child will be worth R2,1 million.

If your child started to save as an adult aged 25 – an active investment of R250 a month between 25 and 65 will only amount to R1,05 million.

That’s double the saving, simply by putting away R250 every month for five years when your child is young.

What about inflation?

There’s one element of which you should remain cautious: inflation, otherwise known as the general rise in price of goods and services.

Inflation is currently running at 6,1% year-on-year. That means the interest you earn must be more than inflation for it not to eat into the value of the money you’re saving. (For example, if your savings generate 5% interest, but inflation is at 6,1%, it means you’ll be able to purchase less with your saving in future than you can today.)

Speak to an experienced registered financial adviser to help you find the best way to make the most of compound interest. Everyone’s situation is different, and an expert could help you find the best savings products for you.

Sanlam Life Insurance is a licensed financial service provider.
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