Why you should start saving today

Why you should start saving today
How to end up a millionaire by starting off with a saving of R10 000
The power of compound interest is often referred to as the eighth wonder of the world. In simple terms, it means that you earn interest on the interest you’ve already earned and reinvested into your savings or investment account.
Darren Cohen
Darren Cohen - General Manager
29 May 2022 | 4 minute read
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.

YearAccount balance at the start of the yearInterest earned at the end of each yearTotal interest earned
1R10 000.00R500.00R500.00
2R10 500.00R525.00R1 025.00
3R11 025.00R551.25R1 576.25
4R11 576.25R578.81R2 155.06
5R12 155.06R607.75R2 762.82
6R12 762.82R2 762.82

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.

Year

Account balance at the start of the year

Interest earned at the end of each year

Total interest earned

1

R10 000.00

R500.00

R500.00

2

R10 500.00

R525.00

R1 025.00

3

R11 025.00

R551.25

R1 576.25

4

R11 576.25

R578.81

R2 155.06

5

R12 155.06

R607.75

R2 762.82

6

R12 762.82

R638.14

R3 400.96

7

R13 400.96

R670.05

R4 071.00

8

R14 071.00

R703.55

R4 774.55

9

R14 774.55

R738.73

R5 513.28

10

R15 513.28

R775.66

R6 288.95

11

R16 288.95

R814.45

R7 103.39

12

R17 103.39

R855.17

R7 958.56

13

R17 958.56

R897.93

R8 856.49

14

R18 856.49

R942.82

R9 799.32

15

R19 799.32

R989.97

R1 0789.28

16

R20 789.28

R1 039.46

R11 828.75

17

R21 828.75

R1 091.44

R12 920.18

18

R22 920.18

R1 146.01

R14 066.19

19

R24 066.19

R1 203.31

R15 269.50

20

R25 269.50

R15 269.50

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

Year

Account balance at the start of the year

Interest earned at the end of each year

Total interest earned

Additional R10 000 per year

1

R10 000.00

R500.00

R500.00

2

R20 500.00

R1 025.00

R1 525.00

R10 000.00

10

R125 778.93

R6 288.95

R32 067.87

R10 000.00

20

R330 659.54

R16 532.98

R147 192.52

R10 000.00

30

R664 388.48

R33 219.42

R397 607.90

R10 000.00

40

R1 207 997.74

R60 399.89

R868 397.63

R10 000.00

45

R1 597 001.56

R1 147 001.56

R10 000.00

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!

Year

Account balance at the start of the year

Interest earned at the end of each year

Total interest earned

Additional R10 000 per year

1

R10 000.00

R500.00

R500.00

2

R21 100.00

R1 055.00

R1 555.00

R10 600.00

9

R138 150.74

R6 907.54

R30 145.12

R15 938.48

19

R498 649.31

R24 932.47

R185 981.86

R28 543.39

29

R1 302 252.30

R65 112.62

R630 966.94

R51 116.87

39

R2 998 756.33

R149 937.82

R1 698 109.57

R91 542.52

45

R4 779 603.03

R2 652 167.90

R129 854.82

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 8% 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 Legal&Tax 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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