Understanding compound interest is one of the most important money lessons ever!
Let’s start with interest.
Interest is the cost of borrowing someone else’s money or the payment received for lending money. If you put your money in a savings account at the bank, it doesn’t just sit in an underground vault; the bank uses your money for investments. They even lend it to other people. For this privilege, they pay you interest.
There are two types of interest: Simple and compound.
Nolwazi explains…
Simple interest is earned only on the original amount you save. Let’s say you invest R100 for five years.
As you can see the R100 base amount remains unchanged. Compound interest is when you earn interest on your savings and on the already added interest. It’s like a snowball rolling down a hill, getting bigger and bigger as it goes.
The difference between simple and compound interest over five years doesn’t seem like much but over time the gap becomes humongous! Why? The Secret Ingredient: Time.
If you save R100 at 10% simple interest per year for 25 years, you will have approximately R350.
If you save R100 at 10% compound interest per year for 25 years, you will have approximately R1083. That’s three times more!
Let’s take it one step further. Say you save R100 per month. After 25 years at an annual interest rate of 10% (compounded monthly), you could have approximately R132 683! More than R100 000 is compound interest – money you earned doing nothing!
What you can do?
Start now: Even small amounts add up over time.
Be consistent: Save regularly, no matter how little.
Be patient: Compound interest works best when you leave your money to grow for a long time. Set up a regular debit order to a savings account and forget about it.
Let’s get practical…
Also read
Savings 101
Source
Manage your money like a grownup: The best money advice for Teens, Sam Beckbessinger
The amounts have been rounded for simplicity.
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