When you're just starting out on your financial journey, you have an invaluable asset that can help you with your financial planning.
In a word? Time.
Whereas older individuals may find themselves scrambling to make up for lost time by taking on certain investment strategies to support their retirement, you have the option of taking a more leisurely approach.
One example of this is compound interest.
Compounding a good thing
Chances are you're familiar with how interest works, especially if you've ever taken on a loan that features a high interest rate. Fortunately, interest can also be a benefit for you.
While there are many savings accounts that allow you to earn interest on the money you deposit, compound interest takes things a step further. In this case, you not only earn interest on the money you deposit, you also earn interest on the interest you have already built up.
In short, you're seeing returns on all the wealth you're accumulating, not just your primary balance.
The Australian Securities and Investments Commission explains it as follows:
"If you invested $10,000 at 5 per cent per year, you would earn $2,500 in simple interest after 5 years, $500 for each year. This would give you a total of $12,500 after 5 years."
"If you invested $10,000 at 5 per cent, you would earn $2,834 in compound interest after 5 years, giving you a total of $12,834. This is because every month the interest is added to your account and you'll earn interest on the interest."
While the difference between regular interest and compound interest may seem small at first, over the years it can lead to a snowball effect that results in huge returns. Of course, this depends on how much money you invest and for how long.
Maximising compound interest
Making the most of compound interest comes back to time. If you're looking for the highest returns, starting early is your best bet.
The younger you start, the faster you can see the miracle of compound interest take effect. Depending on how much you invest, the returns after 20 to 30 years can be truly jaw-dropping.
However, this brings us back to the second most important factor: how much you invest.
In short, the more money you put in, the higher your returns will be, and faster.
Of course, this can be easier said than done, and depending on your financial circumstances, putting a large amount of money away in a compound interest savings account may not make sense.
With this in mind, it's important to weigh your options and determine what kind of investment strategy suits your specific needs.
Comparing and contrasting compound options
The idea of compound interest may be appealing, but not all realities match the potential.
For instance, some financial institutions may compound interest monthly, while others may do so annually. This can make a big difference in the returns you see.
One bank may charge fees for keeping a compound interest account, something that can make this investment strategy prohibitive, especially in the early going.
It's important to do your homework and make sure you're utilising a compound interest investment that offers you solid benefits.
In addition to savings accounts, options like certificates of deposit and stock dividend payments could pay off.
However, before you make any significant decisions, it's a good idea to seek out investment advice from wealth professionals who can answer your questions and help you see the big picture regarding your finances.
The team at MOVO is on hand to help, whether you're interested in interest-paying investments, income protection, budget management or anything in between.