THE POWER OF COMPOUND INTEREST

Tweet

This is the first of several articles I will be posting on my blog touching on personal finance.

Compound interest can be explained simply as earning interest income on interest income, resulting in your money growing at an ever accelerating rate.

Similarly, it can be termed the concept of adding accumulated interest back to the initial investment, which is known as the principal. Doing this means that interest is earned on previously accumulated interest. Therefore when we add the interest back to the principal (making it a part of the principal), it is what is known as compounding.

Albert Einstein once noted that the most powerful force in the universe was the principle of compounding. That was a pretty smart guy there! I wouldn’t argue with him.

How to begin benefiting from the power of compound interest

Start by saving a certain amount of cash every month. Yep, you have to spend considerably less than you earn. 

Put it into an investment that gives affair return at not too high a risk e.g. Some bonds in Kenya currently give 12%.

Don't take it out except to invest in better interest-bearing investments. You might also consider adding additional money as and when it becomes available.

Start saving today. 

Things That Determine Your Compound Interest Returns

Start early: The amount of capital you start with is not nearly as important as getting started early. Every year you put off investing makes your ultimate goals more difficult to achieve. Even modest returns can generate huge amounts given enough time and dedication. The younger you start, the more time compounding has to work in your favor, and the wealthier you can become. Time is the primary ingredient to the magic that is compounding. Do not look to get rich quick

Make regular investments: Remain disciplined and make saving a requirement.

Be patient: Do not touch the money. Compounding only works if you allow your investment to grow.

Rate of return: Don’t put your money in a bank account which would only give you a 2-3% return. You are better off putting the money in bonds earning higher interest and which offer almost no risk.

 Compound Interest Table - The Value of Ksh. 10,000 Invested In a Lump Sum

	4%	8%	12%	16%
10 Years	Ksh. 14,802	Ksh. 21,589	Ksh. 31,058	Ksh. 44,114
20 Years	Ksh. 21,911	Ksh. 46,610	Ksh. 96,463	Ksh. 194,608
30 Years	Ksh. 32,434	Ksh. 100,627	Ksh. 299,600	Ksh. 858,500
40 Years	Ksh. 48,010	Ksh. 217,245	Ksh. 930,510	Ksh. 3,787,212
50 Years	Ksh. 71,067	Ksh. 469,016	Ksh. 2,890,022	Ksh. 16,707,038

The formula for getting the end amount of a sum subjected to compound interest is: P(1+r)^ⁿ

Where P = Principal, r= rate of return you are expecting (in % terms), and n = number of years of investment

If the rate is being compounded more than once a year, then the following formula can be used: P(1+r/t)^^nt

Where t = amount of times the interest is compounded in a year. If semi-annual, then t = 2, if quarterly, then t = 4, e.t.c

The above table is just a simple example of lump sum investing. I also used a very low figure of Ksh. 10,000. Imagine what you would accumulate if you made a habit of saving and investing a figure more than the Ksh. 10,000 above? By adding onto the principle every year, the results would be great.

Now, what are you waiting for? Put it to work! And don’t forget to tell your kids about it too.