Albert Einstein once called compound interest ‘the eighth wonder of the world’. That’s high praise indeed, and places compound interest alongside the Great Pyramids of Giza and the Statue of Zeus at the Olympia. So, how does compound interest work, and, more importantly, how can you make it work for you?

What is compound interest?

Compound interest is a cornerstone of investing. Once you’re able to understand it, you can unlock its domino effect, and let your money do the work for you.

First, let’s look at interest. Simple interest is a fixed percentage payment on a lump sum. Say you have $1,000 in a bank account and see a 3% return for the year. That adds up to a balance of $1,030. 

Compound interest takes this concept but allows you to earn interest on your interest, multiplying your money even further.  

Let’s use super as an example. Take a 25-year-old female, with a starting super balance of $20,000.  If she was to earn the average Australian salary of around $60,000 throughout her lifetime, and with annual investment returns of 5.7%, she would look to retire with $354,148 at age 67*.  

That calculation is based on a steady income throughout her lifetime, and is the combination of regular employer contributions to her account and annual interest compounding to create a super nest egg.  

As you can imagine, once you start to play around with additional contributions the end figure can grow substantially. With salary sacrifice contributions of $100 per week ($5,200 per year), our example member’s super balance would grow to $595,146 by age 67*.

That’s the power of compound interest. Visit the Equip Super Retirement Calculator to see how much you could retire with, and how additional contributions could boost your super over time.  

Compound interest – is it a young person’s game?  

As you can see in the example above, time is one of the most important factors when it comes to compound interest. The sooner you’re able to put your money into an account and leave it there, the more compound interest you can earn.

Starting out at 20 is the best, 30 is great, and 40 is still good. But it is worth noting that the sooner you starter the longer you will have to benefit from compound interest.

Compound interest and super

Topping up your super on a regular basis can make a real difference.  

The good news is most people receive automatic super contributions from their employer. But if you’d like to top that up even further, you have options, including salary sacrifice.  

The term ‘set and forget’ is often used when it comes to super, but this is something that can be beneficial when it comes to compound interest. Over time, small contributions can make a huge difference. As a concept it can be hard to grasp, but once you do, you’ll also start to appreciate it as the eighth wonder of the world.