12/09/2023
Compound Interest, the wonder of the world.
So we are told by family, friends and our financial institutions.
Compound interest is the tool we use to accumulate and generate wealth.
But the point most miss, compounding is a tool that takes time.
The general principle of compounding in layman's terms is as follow: you invest a certain amount, this money appreciates in value. (generally either by capital growth or interest payments)
The following year the capital invested will again grow, but this time the original capital plus the interest earned last year will grow, and each year you will gain additional interest that will also accumulate interest, and so the cycle continue.
It should be apparent that as long as you stay invested the more money you will generate from compounding, however results are slow to be realised for the man/woman starting from scratch, let me show an example.
Assume a growth rate of 10% compounded.
If I had a R1 000 000 to invest, in 7 years time I would have R1 948 717
Clearly this is a good outcome, you earned roughly a Million for just having some patience, but does the average man/woman have a Million Rand laying around to invest, the answer is a resounding NO.
The average consumer would need to start saving a monthly amount.
Lets assume R1000pm (and the individual increases the amount by 6% annually)
After the 7 year period this individual should have R140 658.
(Your actual contribution over this time would have been R100 726 and interest earned would be R39 932)
Notice that this time instead of nearly doubling your total contribution (98.4% increase), you earned roughly 40% increase on your total contribution over the time frame.
SO why does it differ so much?
It is pretty obvious really, your first R1000 contribution had the entire 7 year period to grow and compound, whilst your last payment only had one month.
Though mathematically we can explain this, we have to understand the emotion.
The consumer sacrificed a R1000 of his spending power/enjoyment each month for a 7 year period to receive a roughly R40 000 gain, how much small trips, KFC, McDonalds, Dine outs, Braais etc did the consumer not sacrifice over this time, for which seems like a one or two month salary gain.
Often times over the shorter runs, long-term planning seems to make little sense and feels like a higher sacrifice than gain, but let us continue to keep this contribution for another 7 years and another and see what happens.
If this consumer only did it for 7 years the results would be:
R140 658, but what if he continued another 7 years,
Then he/she would have: R485 584, after another 7 years,
Then he/she would have: R1 264 271, now the consumer has their own million.
So yes compound interest is a fantastic tool, but for the average consumer that starts with monthly payments it takes a little bit more than just patience, it takes:
Monthly sacrifice
Patience, and probably more so than the rest:
It takes conviction.
Along all this time, the consumer could have given up at any time and then never realised the power of compounding, much like planting a seed, you can have the right ground, seeds etc. but if you stop watering the plant it will whither and die out, much similar that would happen to your wealth accumulation if you let the pain of the short-term sacrifices out-weigh the achievement of your long-term goals.
Daniel Matthee
