POSTED ON 21 JANUARY 2019
This is probably the first question you wonder about as a new investor. To leverage the power of compounding interest, it is better to start your investment as early as you can.
For example, you have invested $1,000 with an annual market return of 10% per annum. At the end of first year, you will earn $100 over the period. For the second year, you earn interest on the initial principal PLUS the accumulated interest you have so far, which is $1,100. In other words, you will have $1,100 X 1.1 = $1,210, after the end of your second year.
Compounding interest means accumulating interest on the initial principal and the interest earned from it. In other words, it simply means, “interest on interest”.
Introducing John and Sally – 2 parents who want to get their children's college fund ready for when they turn 20. Let's assume the compound interest on the market returns is at 5% a year.
John, a first-time father, decides to start early and invest S$1,000 monthly for 10 years. After which, he will stop contributing but leave the money invested in the market for the next 10 years.
| Age | Monthly Investment | EOY Bal. |
|---|---|---|
| 1 |  |
S$12,330.01 |
| 2 | |
S$25,290.86 |
| 3 | |
S$38,914.78 |
| 4 | |
S$53,235.74 |
| 5 | |
S$68,289.39 |
| 6 | |
S$84,113.24 |
| 7 | |
S$100,746.66 |
| 8 | |
S$118,231.09 |
| 9 | |
S$136,610.04 |
| 10 | |
S$155,929.28 |
| 11 | S$163,906.92 | |
| 12 | S$172,292.71 | |
| 13 | S$181,107.53 | |
| 14 | S$190,373.33 | |
| 15 | S$200,113.19 | |
| 16 | S$210,351.37 | |
| 17 | S$221,113.34 | |
| 18 | S$232,425.92 | |
| 19 | S$244,317.2 | |
| 20 | S$256,817.01 |
Sally decides to only start investing when her son turns 10. She contributes S$1,500 monthly for 10 years.
| Age | Monthly Investment | EOY Bal. |
|---|---|---|
| 1 | ||
| 2 | ||
| 3 | ||
| 4 | ||
| 5 | ||
| 6 | ||
| 7 | ||
| 8 | ||
| 9 | ||
| 10 | ||
| 11 |  |
S$18,495.03 |
| 12 | |
S$37,936.29 |
| 13 | |
S$58,372.21 |
| 14 | |
S$79,853.68 |
| 15 | |
S$102,434.19 |
| 16 | |
S$126,169.94 |
| 17 | |
S$151,120.06 |
| 18 | |
S$177,346.68 |
| 19 | |
S$204,915.09 |
| 20 | |
S$233,893.94 |
So here's the magic of compounding interest. When their children both turn 20, John who has contributed less ends up with a larger sum than Sally who has contributed more! Due to the snowball effect of compounding interest, he has benefitted from investing earlier.
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