The power of compound interest
If there's any magic in saving, this is it - the power of compound interest. When you're saving, the bank (or financial institution) adds interest to your savings at regular intervals (for example, every month). If you don't touch the interest, but let it add to your lump sum, then you start to earn interest on your interest, as well as on the original amount you saved. This is called compound interest.
The longer you leave your money, the more powerful the compound interest effect. So the earlier you start saving, the more you make from compound interest. The same applies to other investments such as shares, where you regularly reinvest dividends, or the company reinvests its profits.
Consider the example of Viv. Viv's a 20 year old who decides to start saving a regular amount each week. The tables on the next screen show how much she will end up with if she keeps up her saving (either $10 per week or $50 per week) until she is 60. We've based Viv's results on an interest rate of 2.5% after tax and allowing for inflation.
We've also assumed that Viv will increase the amount she saves each week to account for inflation.
If inflation is 2% this year, Viv will increase her weekly savings by 2% from next year (from $50 to $51)
Look at the first five years and the last five years of the $10 table. In the first five years Viv saves $2,600 and earns $170 in interest. In the last five years, she's still saving only $2,600, but she earns a massive $3,970 in interest - far more than she saves. That's the power of compound interest!
Saving $10 per week from the age of 20
Saving $50 per week from the age of 20
The Rule of 72
There’s an easy rule you can use to work out how your savings or investments can grow with compound interest.
Just divide the interest rate (or average annual return) into 72. The result tells you how long it will take for your money to double without further savings.
For example, you have $10,000, which is earning 6% interest (after tax). 72 divided by 6 = 12.
Every 12 years your $10,000 will double, so:
After 12 years you have $20,000
After 24 years you have $40,000
After 36 years you have $80,000
To be completely accurate, you would need to deduct something from the interest rate if you wanted to allow for inflation. For example, if you allowed for 2% inflation, the real interest rate would be 4%.
Use the rule of 72 to remind yourself of the power of compound interest.
User Comments Gaining interest for doing nothing!!
I'm an 18 year old student. Wanting to get ahead in life with money!! So if I can afford the $10 a week for putting money away, and not touching it, the bank gives me interest, for them having it. Why not, I'm not going to turn down (free) money am I?? But it's not free money it's called investment and thinking about things for the future. If you are reading this and think wow, my son / daughter spends their own money like mad. Tell them to open an account with their bank, and put money in it. Which they can't touch and if they do touch it the bank will charge them money e.g. $5, you could say to them, "for every dollar you put in there I'll give you 10 percent", (or more depending on what you can afford), meaning 10 x 52= 520 + 10% 52 = 575, plus the 2.5% the bank will give them. They have now learnt that they have gained almost 100 dollars over a year, for not spending that extra ten bucks a week, and just putting it away!!!, I wish my parents had done this for me. I know it would be far more useful. and I hope that my little explanation has helped!!, Thanks
~Stanley~
Posted at 02:55 pm on October 29, 2008 
Compound interest
That's amazing! I'll teach my son to start saving now. He is 16 years old.
Thank you for the advice!