The Eighth World Wonder

A simple illustration of the power of compound interest.

Albert Einstein once said, 

Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn't, pays it. 

Let's run through a possible scenario for a person who has just turned 30. You look at your bank account and see that your frugal living and continuous saving through your 20s has allowed you to save R1 Million. You plan on not touching this money for 30 years. 

Here are some of the plausible options you can consider:

Option 1: Leave the money in the bank account and earn 4% interest. Capital at end of 30 years = R3 243 397.51 

Option 2: Lock the money away in a long-term fixed deposit and earn 8%. Capital at end of 30 years = R10 062 656.89 

Option 3: Invest in low-cost index funds like the S&P500 which has averaged an annualised return of 10% over the last 100 years. Capital at end of 30 years = R17 449 402.27 

Option 4: Put your faith in a large wealth management firm (PSG, Investec, Allan Gray). They charge higher fees, but their expertise might give you a chance to beat the market and earn 11% after fees. You also experience much less stress, since you do not have to actively manage your portfolio.  Capital at end of 30 years = R22 892 296.57 

Option 5: You are the next Peter Lynch, Warren Buffet or Benjamin Graham and achieve a 16% return for 30 years (highly unlikely). Capital at end of 30 years = R85 849 876.91 

You can look at the graph and make your own conclusions. Probably the most important thing to realise, no matter which financial vehicle you choose, the earlier you start the better and secondly every percentage counts. It is worthwhile to make sure that you maximise your returns and note that a difference of 0.5% in fees can make a big difference over 30 years. Every financial decision you make can have a significant impact, even more so when you are young.

All the interest rates used for this example are fictional and there are no guarantees of any returns.

Disclosure

This is not financial advice and only the opinions of the author.