We hear about the benefits of compound interest so often that we seem to forget about it. We know we have to save, we know we must stay out of debt but somehow we often forget that compound interest plays a vital role in both of these.
I was listening to Bruce Whitfield’s “The Money Show” recently and he interviewed Nicola Kleyn, Dean at the Gordon’s Institute of Business Science (GIBS). She chatted about money and the benefits of compound interest. As I sat listening to her, it hit me again: compound interest can be your friend or your foe. You can either invest money and it grows over time, compound interest working in your favour. Or you can spend on credit, incurring debt, in which case compound interest becomes your enemy.
The problem arises when we as consumers just spend, we buy on a whim, and we buy to fulfil a need or a want. Or we shop because we haven’t planned or we order take-out because we are too lazy to cook. We feel like we “deserve” a treat i.e. a shopping spree or a night out. It might seem like small insignificant amounts but it all adds up and when it comes to saving for our retirement and staying out of debt, every little Rand counts.
On average, as middle class consumers we throw away 30% of our food. That means we are buying 30% more than we need to. If we were to take that 30% and add it to our savings, locally or internationally or add it to our home loan, how much better would our retirement savings look?
I often ask my clients: Why? Why are you saving, why are you sticking to your budget? Once we know our ‘why’, we are able to make more informed decisions about our spending decisions and more determined to say ‘NO’ to unwanted goods and expenses. Some of us might have to ask – ‘Why am I spending?’ Often we shop to fulfil an insecurity or need in our lives. We might be lonely, bored or want to impress others. Once we can determine our ‘why’ we are shopping, we can look at other ways to fulfil that need and rather get on with settling our debt and saving.
A set of twins, a boy and a girl, decide to start saving towards their retirement. The girl saves for 5 years from age 20 to 25, saving R10 000 a year. Her brother only starts at age 25 and saves till he is 65, also saving R10 000 per annum. Assuming no premium increase, excluding tax and assuming the same after costs return of 9%, at age 65 she will have more money for her retirement than her brother. It sounds crazy but that’s the effect of compound interest. If the boy had added a premium increase onto his saving, he would have more than his sister, but the fact remains – compound interest is a powerful tool.