If you had R10, 000 and invested it for 10 years at 10% interest you would be able to retire on an ocean going yacht, own your own island a drive a convertible. Well not quite, but statements like this have almost become clichs in the financial press. The truth of the matter is that most people dont have R1000.00 let alone R10, 000 to invest and their biggest focus is trying to hold onto enough cash to see them through the month. So all the encouragement and happy ever after stories, fall on fallow ground when we know it takes more than a savings plan to get rich.
It is an alarming fact that most people, in spite of having been gainfully employed for ten years or more, would struggle to write out a cheque for R1000 without it affecting their budget. Most of us don’t have large sums of money just lying around waiting to be invested wisely. One of the biggest reasons why we live from pay cheque to pay cheque is that we spend way too much money on debt repayment. But this is not what the story is about, its about dispelling the myth that you need pots of money in order to benefit from the almost magical effect of compound interest.
Just in case you have never heard about the phenomenon of compound interest simply put, it’s when you earn interest today on the interest that you earned yesterday. Say for example you banked R1, 00 yesterday and earned one cent interest. Today you’ll be earning interest on R1.01. The interest that you earn on that one cent is called compound interest.
Unlike some financial instruments you don’t need to be a genius or maths whiz to get compound interest to work for you. There are a few simple rules that apply to ensure that your money will grow and if you apply them consistently you are guaranteed to improve your financial situation.
The longer you save the greater the effect will be. Let’s say you put some money away today at 10% interest. That money will double in about 7 years. If you left the interest in the account you’d have twice as much money earning interest in years eight through fourteen. It’s like you were getting 20% interest on your original savings. By year 15 you’ll be earning 40% interest on your original savings! The rest of the account will earn a less depending upon how long it’s been in the account.
Time and compound interest, work both ways so if you are merrily earning interest on your savings and you have debt, you are paying it back, often at a much higher rate than what you are earning. So it is silly to have a R10, 000 savings account earning you 8% pa and at the same time owe R10, 000 on your credit card at R20% pa. Make sure your debt is under control before you embark on a savings plan.
So how can the financially challenged get compound interest working for them? Well could you find a way to save R50 per month? Maybe you could skip a few fast food trips or limit your bill at your local watering hole? Cut down on the gossip on your cell phone, or stay away from the shopping mall. Dont say I cant save when you know perfectly well that you waste a good 10% of your income on entertainment, designer shoes and other stuff thats youre your cash. You probably think that its almost not worth saving R50.00 per month well, if people had that attitude to all long term projects, cities, ships, dams and anything else that takes years to build, would not have been attempted. If you save R50 per month, and earn 10% per year interest (10% for simplicity sake) and continue to do that for 10 years you will have saved R6000 (120 x 50) but the money will have grown to R10, 037. Not bad for putting the equivalent to a pizza away each month.
If this is exciting you and you know that with a little effort you could save R50 per week or about or approx. 210.50 each month you will have saved R26,000 over 10 years, with interest it would be worth R44,052. You could spend about R4, 400 every year forever and never touch your capital (the actual amount invested). So now you have no excuse, start saving.