How compounding can snowball your savings

Fsp Invest, 13 Sep. 2013

Tags: compounding, power of compounding, the effect of compounding on your savings, interest payment, savings

Compounding is a simple strategy in which you put your money in the bank and you receive interest. You don’t touch the money in the bank or the interest payments. Your interest earns a return too, giving higher interest payments. Let’s take a closer look at how compounding can snowball your savings…

Here's a mind-blowing example of the power of compounding, Tom Dyson explains in The Palm Street Letter

An 18-year-old girl puts R2,000 into an account each year from the ages of 19 to 25. She then stops contributing and lets it compound at a rate of 10% until age 65. That means she has contributed only R14,000 in total. But because of compounding, by age 65, she's almost a millionaire. She has R944,641 in her account.

Now, let's say this girl has a twin brother. He's not as disciplined and continues to blow his money on useless things. Finally, at age 26, he realises he needs to start saving, too.

He puts R2,000 per year into his account starting at age 26. He also lets his money compound at a rate of 10% until age 65. Except he contributes R2,000 every single year from ages 26 to 65. That means he's contributed R80,000 in total. That’s’ more than five times what his sister has contributed.

By age 65, he's almost a millionaire, too, with R973,074 in his account.

Who's the compounding winner?

The sister contributed only R14,000 (R2,000 per year over seven years) and ended up with R944,641. That's a net gain of R930,641, or 66 times her original investment.

The brother contributed R80,000 (R2,000 per year over 40 years) and ended up with R973,074. That's a net gain of R893,704, or 11 times his original investment.

The sister was able to accomplish much better results with much less money. All because she realised the power of compounding money over long periods of time.

So there you have it, how compounding can snowball your savings.

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