Two Words: Compound interest!

By Chiara Sewpersadh, Associate Investment Consultant

Why exactly should you start saving and investing as young as possible, why not leave that for when you’re earning more money?

More often than not, younger people feel the pinch of their salaries not affording them the lifestyles which they want. For every individual there is a different reason why they cannot save and it is justified that savings are simply not affordable. After all, you are working hard for your money so why not enjoy it as you earn it? However, there are a number of reasons why you should start saving and investing as early as possible.

The most important reason is two simple words: Compound interest.

Compound interest, the eighth wonder of the world in the eyes of Einstein, has long been working for global billionaires such as Warren Buffet and Bill Gates. They understood from an early age that the more they saved, the more they could earn on the savings.

The concept is that if you save money, earn returns on it and do not take any money out that you are then able to earn on the initial money invested plus the returns.

As you can see the same percentage return becomes more monetary return. Now consider the following savings table.

Assuming 6.30% per annum rate compounded monthly, which signify cash returns at the average rate for a tax-free savings account with total annual contributions between R5 000 – R9 999 (0.53% per month).

Consider the monthly investment of R500 per month over 40 years, the total investment is R240 000 while the amount returned is over R840 000 showing that the long term impact of compounding this monthly saving leads to a return of approximately 350%.

As the graph below shows, a person who invests for only 10 years starting at age 20 and leaving the investment in the market for the next 40 years would realize a higher end value on a smaller investment than a person who starts investing at age 30 and continues to invest for the next 30 years until the retirement age of 60, assuming an annual return of 10% compounded annually.

The second reason is what is known as the “gateway effect of a savings account”. Global studies have shown the positive relationship between people who have a savings account at an early age verses those who potentially never open one up.

Early built up savings lead to a far greater probability of asset accumulation through the person’s life, with some of the following reasons:

Having savings in unexpected situations or emergencies means not needing to borrow;

Financial flexibility to invest in different assets and generate superior returns;

Less reliance on credit for financing; and

Reducing monthly repayments of housing and other financed assets through better down payments.

The number one golden rule to help you start saving is SPEND LESS THAN YOU EARN! Taking out credit is ruthlessly expensive and reduces your ability to save for a lot longer as well as that this allows you maintain living off less through life which enables your savings.

The second thing to remember is that no amount is too little. As we showed earlier the power of compounding will grow any amount of money over time.

And the final aspect to consider is the saving and investment vehicle or product. The last thing which you want to do is pay some of the banks’ bills by lending them money and not generating sufficient returns on your delayed gratification.

One of the simplest and more efficient products would be the range of tax-free savings accounts offered on the market. These accounts are flexible and do not require hefty amounts of money to be invested. There are a number of tax-free savings accounts which offer the benefit of reduced tax costs and varied monthly returns depending on the size of your investment. As such, as your money grows, so too will your return.

Of course we know that the MOST tax efficient form of savings for any individual is through your retirement fund, be it a pension or provident. Reason being that any contributions made are tax-free up until retirement, which allows you to benefit from compound interest on a higher amount over a much longer term.

So don’t just work hard for your money, let your money work harder for you!

 

Disclaimer: This publication provides information and opinions of a general nature. It does not constitute advice and no part thereof should be relied upon without seeking appropriate professional advice.