Wise words that are often attributed to Albert Einstein … or John D. Rockefeller … or Baron Rothschild … or perhaps Napoleon, maybe …
No-one truly knows but whoever it was, they were absolutely right.
Sure, all of us know how our bank accounts work: we deposit money, the bank pays us an interest rate on our savings, and if we leave those savings alone, the following year we receive interest on the interest i.e., compound interest.
However, what we often ignore is the true potential of compound interest!
Before I go on to explain the above statement, I must clarify that your regular bank account is not the best place to take advantage of the true potential of compound interest. And this is because the interest rate on a current account has been abysmally low for years (often as low as 0.01%). That said, the principle applies whether we talk about bank accounts, the stock market, retirement funds or any other savings goal.
So, coming back to my earlier statement, let us presume that you wanted to save for your retirement. As you can imaging, how much you require for your retirement will vary on your lifestyle and the country in which you retire, but the following are some rule-of-thumb suggestions:
About $1m
12 times your pre-retirement salary
Enough to provide 70-80% of your annual pre-retirement income.
For the sake of this discussion, let’s take $1m as our target to have saved by the age of 65, and that we’re happy to invest in the stock market with returns of 7% per year.
Scenario 1: If you were to start saving at the age of 25, you would need to save approximately $389 per month to reach your goal at age 65.
Scenario 2: If you opt to wait until 55 to start saving, your per month savings jumps to a whopping $5,280!
Do you see the impact of compound interest in both these scenarios? That’s better than any bank account interest ever!
If you compare the two scenarios above, you’ll notice that the 25-year old’s accumulated savings is over $475,000 by the time the 55-year-old has barely started saving!
And yes, I realise that saving $389 at the age of 25 seems like an impossible proposition … however, if you start with just $100 per month at age 25, then increase to $300 at age 35, notch it up slightly to $500 at age 45 and then boost it to $700 at age 55 you can still get to $1 million with a little left over.
If you’re well past 25 and wondering how to make amends. Well, don’t worry, whilst the best time to start was in the past, the second-best time is right now. Here are some middle ground options in achieving your retirement goal of 1 million dollars:
Save $817 per month from the age of 35 onwards
Or save $1,858 per month from the age of 45 onwards.
I hope this example helped shed some light on the magic of using compound interest to its full potential. And if you don’t feel like working through all that math, and feel a bit overwhelmed with your options, then don’t forget to check out HAYAH’s Smart Saver, which is designed to ensure your goals are in reach – whatever they are.