Compound interest is 2019 buzz word

The author advises consumers, particularly those who have debt, to look into the concept of compound interest.
The author advises consumers, particularly those who have debt, to look into the concept of compound interest.
Image: Jrg Stber/123rf

In the first monetary policy committee meeting of this year, the Reserve Bank announced that interest rates will remain unchanged .

This is good news for those who have debts. This brings me to an exciting concept that can be used to improve your financial position with less effort.

Compound interest is a buzz word that many financial advisors mention to clients who want to get the most out of their savings.

According to Wikipedia, compound interest is the addition of interest to the principal sum of a loan or deposit. In other words, it is interest on interest.

It is the result of reinvesting interest, rather than paying it out, so that interest in the next period is then earned on the principal sum plus previously accumulated interest.

Suppose you save R100,000 at a 10.5% rate for a fixed term deposit of five years. When you don't have interest paid out, it is effectively reinvested and earns interest again at the annual compounding rate.

The payout at the expiry of the five-year term would be R164,745. This scenario is one of the reasons why compound interest is a wonderful concept.

Since simple interest is calculated only on the principal amount of a loan or deposit, it's easier to determine than compound interest.

In our example, if you decide to be paid annual interest instead of awaiting the five-year term to expire, the payouts would be on a simple interest rate basis. The initial R100,000 invested would equate to a payout of only R152,500.

According to Businesstech, to get the most out of compound interest, you should look at the following:

  •  Be sure you are comparing the same rates on products.
  •  Also remember it is always better to leave your interest in the institution and let it accumulate for as long as possible to receive the greatest return.
  •  You should always invest with a reputable service provider.
  •  If possible don't withdraw interest. Reinvest it.
  •  Check if you will pay penalties if you withdraw your deposit early, what you can withdraw and when.

The power of compound interest shows how you can really put your money to work and watch it grow. When you earn interest on savings, that interest then earns interest on itself and this amount is periodically compounded.

At the Financial Planning Institute we recommend the simple Money 123 principle which entails reducing debt, setting up an emergency fund and saving (or investing) in that order.

  • Sekese is a certified financial planner professional and member of the Financial Planning Institute (www.fpi.co.za)

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