How To

How compounding returns turbocharge your net wealth

Wed 23 Feb 22, 6:46pm (AEST)
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Key Points

  • The principles of compounding returns apply to any investment
  • Squirrelling away small, yet regular amounts makes a huge difference over time
  • Einstein called ‘compounding returns’ the most powerful force in the universe

Albert Einstein called ‘compounding returns’ the most powerful force in the universe and you don’t need a super huge IQ to work out why.

Stripped down to its budgies, compounding returns is all about how adding regular amounts to the money you’ve already got can accelerate your savings at a much faster rate.

Compounding versus annual

For starters, let’s look at the difference compounding interest monthly versus annually can make.

For example, take $25,000 in a savings account earning 4% interest annually, and after five years you’d have $30,000.

However, if your interest compounds monthly, you’ll simply earn more money. That’s  because it’s being calculated on a higher balance each month.

For example, if you had the same $25,000 in a savings account earning 4% annually that’s also compounding monthly, after five years you’d have $30,525.

That’s great – a difference of $525 with no extra effort from you.

But if you continue to put money into your savings, you’ll effectively put a grenade under your ability to save more, and that’s got to be attractive in anyone’s language.

Small, regular amounts stack up

One of the single biggest reasons for saving or making additional contributions to your super is to reap the benefits of both capital growth, and the power of  compounding returns.

Believe it or not, squirrelling away small, yet regular amounts makes a huge difference  over time.

Five-fold-plus increase over 30 years

Here’s one powerful example that most people have the ability to implement right now.

What would happen if you put aside $50 a week and invested it into the share market every time you save $1000?

Short answer: If those shares earned 9% annually, in 30 years you’d have $442,000 in wealth – and this would be achieved by investing only $78,000 of your own money.

That’s a brilliant outcome, and you can apply the principles of compounding returns to literally any investment.

Key drivers of compounding returns

The principles of compounding returns are based on three key drivers, including the  rate of return (or the interest rate you receive), the amount of money you contribute,  and the timeframe you choose.

The beauty of committing to a longer timeframe is that every month, the rate or return (or interest rate) is calculated on a higher balance than the month before (aka returns on returns).

Remember, every time the boss pays your super guarantee (SG) contributions, you’re repeatedly getting returns on higher monthly returns, and maximising the power of compounding interest.

But you can also give your savings balance an additional nudge by doing your own ‘heavy lifting.’

For example, every time you make additional contributions to your super, either through salary sacrificing or non-concessional amounts (on which you’ve already  paid tax), you’re maximising the overall effect that compounding returns will have on your money over time.

What are you waiting for..?

Remember, compounding interest also works in reverse, so instead of paying the bare minimum on your card monthly - try and clear the debt as fast as possible.

Written By

Mark Story

Editor

Mark is an investigative financial journalist and editor who started his career working for Marathon Oil in London. He has a degree in politics/economics and a diploma in journalism. Mark has worked on 70-plus newspapers and financial publications across Australia, NZ, the US, and Asia including: The Australian Financial Review, Money Magazine, Australian Property Investor and Finance Asia. Mark is passionate about improving the financial literacy of all Australians through the highest quality content. Email Mark at [email protected].

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