Compound Interest

The Eight Wonder Of The World

Compound interest refers to additional interest received on both the original sum of money invested and the interest that has accumulated over time. In short, your money makes money - without you doing a thing about it.

It is not only enticing, but crucial too. In October 2021, Singapore's overall inflation rose 3.2 per cent, hitting the highest it has been in eight years, with the prices of food, amenities and services going up. In the battle against rising costs, compounding is becoming more important than ever.

As Einstein said, "He who understands it, earns it. He who doesn't, pays it." Here's how compounding can help turbo-charge your finances.

The power of compounding

First, it is key to understand the difference between simple interest and compound interest.

• Simple interest is calculated based on the principal sum of money at a given rate over a period of time.

• Compound interest, on the other hand, is the sum accrued from both the principal and the accumulated interest.

In addition, the Rule of 72 is a quick and easy method to calculate how long it will take for your initial investment to double.

The formula is simple: Divide 72 by the interest rate. For example, if you were to stash away $10,000 in an investment account with an annual interest rate of 3 per cent, it would take about 24 years before that figure doubles to $20,000.

Slow and steady wins the race

Maximising the benefits of compound interest requires plenty of time and patience. The key is to start early. In fact, starting earlier with less money results in higher earnings, rather than starting later with more money. 

And rather than putting all your money into a savings account where interest rates are close to zero, there are better ways to grow it. For instance, by investing it in a balanced fund.

No time to lose

Warren Buffet, one of the most successful investors of all time, made compounding a key cornerstone of his investment strategy, earning billions in the process.

This should be a core pillar of your financial approach too. Start early, invest strategically, and you may be reaping bountiful rewards down the road. Understand how it works, give it some time, and reap the rewards of patience down the road.

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