With something as immensely powerful as compound interest at the fingertips of every income earner, it’s a wonder that so many South Africans are hopelessly under-invested for retirement. With an abundance of investment vehicles and asset managers to choose from, it’s most certainly not a lack of choice or access that has given rise to the less-than-adequately-invested multitudes. As the unofficial eighth wonder of the world, compound interest provides scientific and consistent evidence that when it comes to investing time is indeed an ever-faithful friend. Whilst it may wreak all manner of havoc on the human body, father time is abundantly generous when it comes to invested money earning compound interest.
The word ‘compound’ in the context of investing literally means to grow on top of oneself, allowing one to earn interest on top of interest. Practically, as your principal investment earns interest, you continue to earn interest on any previously earned interest, with the results becoming fascinatingly exponential over time. Although the effects of compound interest may be sluggish at first, the increasingly exponential power of compound interest at work becomes almost magical to witness. If one considers that time is the greatest ally of compound interest, it becomes trite that a lack of time is the greatest obstacle to true wealth. In fact, understanding the real cost of delaying ones retirement funding is sometimes best depicted numerically. The example below represents the approximate amount a person would need to save in present value terms in order to achieve a post-retirement income of R25 000 per month, assuming a life expectancy of 100 years.
|Begin investing at||To retire at age 60||To retire at age 65|
|Age 25||R6 500 pm||R4 167 pm|
|Age 30||R9 000 pm||R6 000 pm|
|Age 35||R12 500 pm||R8 333 pm|
|Age 40||R17 500 pm||R11 667 pm|
As supremely powerful as compound interest is, its long-term effectiveness remains limited by the inherent inability of humankind to delay gratification. To fully harness the magical power of compound interest one needs to make a long-term commitment to investing without interrupting the process. For many South Africans, moving between employers provides an all-too-tempting opportunity to access ones retirement funding as opposed to preserving the investment. The instant you choose capital withdrawal over capital preservation, you prematurely stop the powerful cycle of compounding and effectively waive your rights to future investment gains.
Although seemingly simple to do, it appears that adopting a hands-off approach to ones long-term investments is frustratingly more difficult than it sounds. Advising an avid investor to do absolutely nothing other than wait is akin to recommending he watches the grass grow. Sitting back and allowing compound interest to work its scientific magic flies in the face of mass investment media which is saturated with advice on market-timing, stock-picking and the hottest shares. Responding emotively to volatile market movements has resulted in many an over-zealous investor interrupting the compounding process and single-handedly destroying his wealth, when all he really had to do was absolutely nothing at all.
As long-term investors preparing for our retirement years, we’ve been gifted with two indomitable tools – time and compound interest. When these two powerful tools are permitted to work together in perfect synergy they have the capacity to almost magically transform our investments into remarkable and lasting wealth. Our advice to those who are serious about their retirement funding is to allow time and compound interest to run their cumulative course, and whatever you do, don’t stop the magic.
Categories: Lifestyle Financial Planning