Wealth Creation

Compounding – what is it? Is it “magic”?

Updated September 2023

BiG Tip: The power of compounding is that it makes your money (and debt!) grow faster. This vital concept can make, or break, your financial success.

MoneySmart’s (ASIC) Compound Interest section says:

The power of compounding helps you to save more money.
The longer you save, the more interest you earn.
So start as soon as you can and save regularly.
You’ll earn a lot more than if you try to catch up later.
MoneySmart

For example, if you put $10,000 into a savings account with 3% interest compounded monthly:
After 5 years, you’d have $11,616. You’d earn $1,616 in interest.
After 10 years you’d have $13,494. You’d earn $3,494 in interest.
After 20 years you’d have $18,208. You’d earn $8,208 in interest.”

Noel Whittaker says compounding is: The most important money lesson you’ll ever learn [You Tube]. He shows you how compounding works and why starting early can make a huge difference to your future.
Watch Introduction to interest Interest and debt| Finance & Capital Markets| Khan Academy USA
How does compounding work? Have a play with MoneySmart’s Compound Interest Calculator.

Compound interest formula
To calculate compound interest, use the formula:
A = P x (1 + r)n

A = ending balance
P = starting balance (or principal)
r = interest rate per period as a decimal (for example, 2% becomes 0.02)
n = the number of time periods

How to calculate compound interest
To calculate how much $2,000 will earn over two years at an interest rate of 5% per year, compounded monthly:

1. Divide the annual interest rate of 5% by 12 (as interest compounds monthly) = 0.0042
2. Calculate the number of time periods (n) in months you’ll be earning interest for (2 years x 12 months per year) = 24
3. Use the compound interest formula
A = $2,000 x (1+ 0.0042)24
A = $2,000 x 1.106
A = $2,211.64″

BiG Tip: There’s no time like the present. Time’s on your side so get onto it!

Maybe you don’t know where to start, are afraid of making a mistake, don’t have the time or haven’t got enough money saved to start.
If you can take one small step towards a better you, it really will be worth it. Here are some reasons why getting moving now’s a good idea!!

Top Investments for Young Australians in 2021, Canstar They say: “Start sooner rather than later. We’ve all seen the Compare the pair ads where Alice and Bob both make the same salary but Alice’s super provider has a better return, and by the time they retire she has thousands more in her account than Bob. Compound interest is a strange and powerful force and over time can make a huge difference to your investment. If you were to start saving while you’re young, even if it’s only a small amount, you’d have time on your side to grow your money. A little now can add up to a lot later, especially with the help of compound interest. You can start investing with as little as $500 in an exchange-traded fund or $1000 for a managed fund.”

Check out:

5 Great Charts on Investing – Priority1 Wealth (acknowledging Dr. Shane Oliver, Head of Investment Strategy and Chief Economist AMP Capital) who say: