Discovering the Power of Compound Interest
The reader stories I've been featuring on Sunday for the past three months seem to be a resounding success. Instead of being the only one to read your triumphs and failures, the rest of the GRS community can share them, too. I have no plans to expand this feature beyond Sunday, but I'm making an exception today. This short post from Jess Rundell fits with April's “financial literacy” theme, and I think it's worth sharing.
Since you always stress the magical properties of compound interest on your blog, I wanted to tell you a story about how I have learned the value of compound interest for myself. Intellectually, I've been aware of compound interest, and the fact that I should begin to save for retirement as young as possible, but after today I know this to be true.
I'm 21 and a final-year undergraduate university student. Although I've never had a “proper” job, I've had a few part-time jobs, and for 6 months when I was working in a call centre last year, I joined the pension scheme, although most of my friends thought it was a bit weird.
After I left the job to focus on my studies, I didn't think much of the pension fund, and I stopped paying into it because I'm extremely poor without any income except for my loans. But today I got my first yearly statement from the company managing the pension.
Apparently, I paid around £100 into the account, and my employer paid around £200 into it (free money!). The statement informs me that, if I pay no more money into my account, the approximate amount I'll have at age 65 will be worth nearly £20,000, or £725 income a year (in today's prices, so taking account of inflation).
Now, it does stress that this depends heavily on various factors that I don't really understand. But at face value, this essentially means that I turned £100 into £20,000 simply by filling in a form allowing the company to take it from my paycheque pre-tax. I didn't miss the money — less than £20 a month, the equivalent of two paperbacks or going for lunch with a friend — and it wasn't terribly onerous filling in the form.
I graduate in June, and as soon as I start working, I'll be resuming payments into my scheme. It's amazing how much motivation looking at my statement today provided. I feel like I understand compound interest for the first time ever.
J.D.'s note: It's always interesting what makes a concept “click” for one person. For Jess, seeing projected returns on a small retirement investment made him see the light about compound interest. I clued into compounding when I saw the cost of waiting one year…