Compound interest is one of the most powerful forces in the universe when applied early in a savings journey. Standard Bank Savings and Investments guru, Takumi Daling, says the benefits are particularly eye-popping the younger someone is when they embark on their savings strategy.
“Of course, there is never a bad time to start saving and we recommend those who do not have a strict culture of saving in place, start today. However, what my research has found is that the combination of compound interest and saving from a young age, is nothing short of amazing,” she says.
Even if you are not “rolling in cash”, getting into the habit of saving now will condition you to keep saving and ensure you reap rich rewards thanks to the power of earning interest on interest.
Daling’s research shows that a child who invested only R1,000 once-off at birth and earned a 10% annual return, would have amassed a staggering R789,747 by their time she turned 70.
In contrast, someone who invested R1,000 every year at a 10% return – but started at age 30 and saved to age 65 – would have a lot less – just R487,852 when they turned 70. They would also have invested R41,000 compared to the R1,000 invested by the child.
To highlight the point further, someone investing R1,000 a year from age 22-29 at 10% annual interest would have invested a total of R8,000 and would be able to walk away with R569,338 when they turn 70.
“Even that third scenario is decidedly better than the person who starts late in life. Of course, we should all be aiming to be more like the first person, and then also invest more to ensure the effect of compound interest is maximised,” says Daling.
Here is an easy way to understand the different scenarios:
Child:Investing only R1 000 once-off for a child at birth (@ 10% annual return)
Mary:Investing R1 000 per year from the age of 22 to the age of 29 (@ 10% annual return)
John:Investing R1 000 per year from the age of 30 to the age of 65 (@ 10% annual return)
The results are astounding:
Child age 0
Years of investing
Daling cautions that any discussion on saving needs to take the negative effects of inflation into account. “You need to increase the amount you save each year by at least the inflation rate,” she says.
In order to give you a clear picture of how inflation affects your pocket, it is necessary to look to the future. Let’s assume that food costs, on average, rise by 7% per year over the next 10 years and your take home pay rises by 4% per year.
If you are currently spending R2,000 per month on groceries and your take home income is R10,000 per month – your grocery bill will equal 20% of your take home pay. Ten years from now the same groceries will cost you (at 7% inflation) R4, 020. If your salary increases at 4% per year over the same period your take home pay will be about R14, 908. This means that your household shopping would then represent 27% of your take home pay. So the impact of this is that you will end up paying more money on basic goods and your standard of living “would take a knock”.
“The above scenario carries huge significance for everyone who is saving money for their own home or retirement. If you save R500 per month and only achieve a 4% net return against inflation of 7% per year, you are actually going backwards in terms of buying power,” says Daling.
This is of course the worst-case scenario, but what it illustrates is that when you save, you have to be aware of the effects of inflation on your money.
Says Daling: It is no good saying you can afford to save R100 per month and then keep your savings at that level into the future. You need to increase your annual savings by at least the prevailing inflation rate to see a decent return on your investment.
“Whichever way you decide to save, you will see the results if you are consistent and get the right help from the start. Start now so you can relax about your future and achieve the lifestyle (and retirement) you are working so hard for,” concludes Daling.