Compound Interest: “The eighth wonder of the world”

24 May, 2019 / In Investing / By Chris Burnett

By Chris Burnett

Albert Einstein once proclaimed compound interest to be the ‘eighth wonder of the world’.  So what is compound interest and what makes it so wonderful?

Compound interest is essentially interest earnings that is paid on your interest earnings.  If you make an investment and instead of withdrawing any earnings on the investment at the end of the year, reinvest those earnings, in the next year you’ll earn interest on the initial investment and you’ll earn interest on the amount you have reinvested. 

Over time the earnings on the investment will compound and eventually start to do more of the ‘heavy lifting’.  In other words, you will eventually earn more interest from the compounding effect that you will do on any initial principal investment!

As an example, if you put $100 into an investment that generated a fixed return of 10% per year you would have earned $10 after your first year.  If you decided to reinvest that $10 you would earn another $10 on the initial principal investment in the second year plus an extra $1 on the earnings you reinvested.  The additional $1 represents earnings on your earnings. 

In the third year you would receive earnings of another $10 on your principal, $1 on the reinvested earnings from year 1 and $1.10 on the reinvested earnings from year 2.  Already after only 3 years your earnings would increase from $10 per year to $12.10 per year.  Hence the compounding effect.

After 30 years the total earnings per year would grow to almost $160 per year with only $10 of that being from the initial principal investment of $100.  A whopping $150 is interest on the previously earned interest.  After 30 years the initial $100 investment will grow to $1,745!

After seeing the potential even a small investment can make, your future self will be thanking you for putting away small but regular amounts now.  As you can’t access your super until retirement, making additional contributions to your super now can be an easy way to let compound interest work its magic for you – add you may be able to get a tax benefit along the way. 

Get in touch with us today if you want to discuss the benefits about setting up a regular investment plan or making additional contributions to your super.