Why you should start saving today

Compound interest accelerates the growth of your savings over time because you earn interest not just on your initial investment (referred to as the principal), but on the principal plus the reinvested earnings or interest.

Simple versus compounding interest

Simple interest is the term used to explain interest earned only on the principle amount you invested. Simple interest paid or received over a certain period is usually a fixed percentage of the principal amount that was saved (or borrowed).

To calculate the simple interest you would earn, use the formula P x I x N where:

P = Principal

I = Interest rate

N = Number of interest earning periods

For example; assume you save R10 000 earning 5% per year, for five years. You would have:

R10 000 x 5% x 5 years = R2 500

So after five years you would have R10 000 + R2 500 = R12 500.

Simple interest does not compound.

Compound interest explained - If we used the same figures but earned interest on the principal investment and reinvested interest each year the end result looks different.

So, by investing the same amount into a compound interest account you end up with R262.82 more after five years than if you invested in a simple interest savings account, or withdrew your interest earnings each year.

Instead of having to calculate the compounded amount at the end of each year, you can use the following formula:

[P (1 + i)ⁿ] – P

Which takes the total amount of principal and interest in future (or future value) less principal amount at present (or present value) where:

P = Principal

i = Interest rate

n = number of compounding periods

[R10 000 x (1 + 5%)^{5 years}] – R10 000

=R2 762.82

Investing for longer periods pays off, which is why you should start now

If we assume the same investment criteria, but over 20 years, the true power of compound interest becomes a lot clearer. After ten years you would have earned R6 288.95 interest. After 15 years R10 789.28 in interest and after 20 years R15 269.50 in interest.

If we followed this logic over a longer period, say 45 years of your working life, you would end up earning R75 571.50 interest, with a final total investment (including your initial R10 000) of R85 571.50

But there’s more to the picture

It’s unlikely that you would save or invest just once off in your life. What is the impact on your savings if you keep adding to your savings over the course of your working life?

Let’s assume that each year you save R1 000 per month excluding ‘Januworry’ and December, so R10 000 per year, and add this to your savings too. The table below illustrates how you would end up with almost R1.6m

Now let’s take it one step further and assume that you get a 6% raise each year and increase the amount you save by the same 6%. After 45 years you end up with a staggering R4.78m!

Choosing the right investment for your needs

You should speak to a financial advisor to help you plan for your needs. Many investment vehicles are available depending on when and why you need to save, from shorter term investments to longer terms reasons like retirement.

In this article we assumed a 5% annual interest rate, but currently you could earn as much as 10% ^{(updated as at April 2024)} or more in a fixed deposit with a bank, and possibly much more in other investment types, but bear in mind with the promise of greater reward, there may be higher risks too.

With Solace you’re not alone

No amount of saving is too little. If you need assistance setting up your budget to help you save for you ensure you cover your monthly expenses and are able to save for your future, your child’s education, or even for a rainy day, our Money experts can help.

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