The power of compound interest

You’ve probably heard the saying “the sooner the better”. While the retirement pension may not have been written about, it’s a philosophy that many savers live by in pursuit of building up a big nest egg for their retirement.

Indeed, small but early contributions to the super can result in large retirement balances, thanks in large part to the power of compound interest.

How does compounding work?

Compounding means that you receive interest on both your principal investment and your interest. In other words, you receive interest on top of your interest.

Over time, these additional interest injections can result in a large balance, with the amount of interest you earn being proportional to the length of your investment: the longer the investment horizon, the greater the amount of compound interest. raised.

The compounding effect is perhaps best demonstrated with an illustration. Let’s say a 30-year-old man receives a bonus at work and decides to put $10,000 into super. Assuming a modest average annual return of 5%, that same $10,000 investment would be worth $44,677 at age 60. Over that 30-year period, they would earn $34,677 in interest, just for being invested.

Why Performance Matters

Of course, the amount of interest a person earns can be higher or lower depending on the performance of their super fund. This is why it is so important to be invested in the right fund and to choose the right risk profile for your objectives.

Active Super had a bumper year in 2020-21, delivering record returns of over 23% under the accumulation program. Over the past 10 years, the program’s High Growth option has returned an average of 9.76%*.

Even a small difference in performance can make a big difference in retirement. Let’s say the same 30-year-old man invested $10,000 again, but this time he got a slightly higher return of 6%. A percentage point doesn’t seem like a lot, but over time it has a significant effect on the outcome. This time, the balance after 30 years would be $60,226, more than $15,000 more than the saver would get at 5%. At 7%, this same investor would have earned $81,165 over 30 years from his initial investment of $10,000.

Ways to build your super savings

For those who want to boost their balance, there are several ways to add more to super. A popular strategy is to sacrifice salary, where additional contributions are deducted from your pre-tax salary. In addition to adding to the super balance, taxable income is reduced, which can mean a lower tax bill at year-end.

In addition to sacrificing pay, people can also increase their super with personal contributions from their after-tax pay. With pre- and after-tax contributions, it’s important to keep an eye on the annual contribution limits, which are $27,500 and $110,000 respectively, and eligibility rules apply.

contact us to learn more about which strategies and goals are right for you.

*Past performance is not a reliable indicator of future performance.


About the author