Financial Education - Whai Rawa

Building knowledge

We have attached information on some concepts essential to financial goal setting and achievement.

Compounding Interest
Saving Regularly
Value of starting now

Compounding Interest

If there's any magic in saving, this is it - the power of compound interest. When you're saving, the bank (or financial institution) adds interest to your savings at regular intervals (for example, every month). If you don't touch the interest, but let it add to your lump sum, then you start to earn interest on your interest, as well as on the original amount you saved. This is called compound interest.

The longer you leave your money, the more powerful the compound interest effect. So the earlier you start saving, the more you make from compound interest. www.sorted.org.nz

The Rule of 72

There’s an easy rule you can use to work out how your savings or investments can grow with compound interest.

Just divide the interest rate (or average annual return) into 72. The result tells you how long it will take for your money to double without further savings.

For example, you have $10,000, which is earning 6% interest (after tax). 72 divided by 6 = 12.

Every 12 years your $10,000 will double, so:

After 12 years you have $20,000
After 24 years you have $40,000
After 36 years you have $80,000

To be completely accurate, you would need to deduct something from the interest rate if you wanted to allow for inflation. For example, if you allowed for 2% inflation, the real interest rate would be 4%.

Use the rule of 72 to remind yourself of the power of compound interest.

Start saving $10 a week when you're twenty, and by the time you're the age in the left hand column, you'll have saved the amount in the right hand column. And look how the power of compound interest makes your savings grow!

*rounded to the nearest $10 www.sorted.org.nz

Saving Regularly

The key is to build the habit of saving. Once you have got used to putting away money regularly – then your money begins to work for you, by compounding and growing. Over time, regular saving can build up to reasonable totals as the table attached shows.

Go to the sorted website on www.sorted.org.nz and try out the saving calculators to see good examples of the benefits of saving regularly.

The Value of Starting Now

We have enclosed some detail around the value of starting now, rather than waiting and starting in the future.

Example: Jim and Mary are both 22. They both want to save $1000 a year for retirement.

Mary starts saving at age 22 and saves for 20 years, until she is 42. Mary then leaves her savings to compound.

Jim starts 10 years later at 32 and saves for 33 years until age 65.

Both earn 4% on their savings every year.

Who do you think has more money at age 65?

Mary has built a fund of $76,327 at age 65.

At age 65, Jim’s fund is $68,855,

Jim put more money into his savings but because Mary started early and gave her savings more time to compound, Jim was not able to catch up.

There are more examples on the Retirement Commissioner’s website www.sorted.org.nz Go there and have a look around, the site is very interactive and interesting.