Previously I wrote about good and bad debt and this week I want to look at cumulative interest. Compound interest is the strongest force in nature, according to Albert Einstein.
How can it be so powerful? How does it work?
Take a set of twins for example; Mary saves R1000 a year from age 20 to 35 – a total of R15 000. Her sister Anne saves R5000 per year from age 40 to 65 – a total of R125 000. Who has more money at age 65? Interestingly, it is Mary who will have more money at age 65. Mary will have R1 250 925 and Anne R746 669, assuming a 12% growth on investment annually. Mary will have more money at age 65, even though she saved less than her sister.
Often I get asked if it is not better to settle all one’s debt, for example bond and car repayments before starting to save. But it is clear from the example above, the sooner you start saving, the better.
If you were to take a ball of snow and roll it down a long, steep mountain covered in snow. By the time it reaches the bottom, it would have accumulated so much snow that the ball would be enormous. If you were to take a second snowball, bigger than the first and roll it down a smaller hill covered in snow, it will not be as big as the first snow ball. The reason being that the hill was not as steep nor as long as the mountain.
Cumulative interest works similarly. Assuming the mountain/hill is symbolic of time and the size of the ball, symbolic of your investment amount: the steeper the hill, the better for your investment.
Get your snowball rolling down the mountain by investing sooner rather than later. It’s never too late to start!
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