I’m envious of 20-somethings and their KiwiSaver accounts. Those who have started salting a small portion of their income away at such a tender age will be amazed at how their money grows.
The miracle of compound interest really does work. Compound interest is the snowballing effect when you reinvest interest on an investment and get interest on interest.
For example, if you invest $1,000 for a year and get 6% interest of $60, which you reinvest. Next year you’re earning interest on $1,060. The following year 6% interest on $1,060 is $63.6. Each year the amount of interest earned on the original $1,000 gets larger and larger because you’re reinvesting your returns.
Compound interest really is the eighth wonder of the world. Albert Einstein, who wasn’t exactly a thicko, called compound interest "the greatest mathematical discovery of all time".
The same concept works for all types of savings including shares, property investments, bonds, and so on, providing you reinvest your interest, dividends, surplus rent or other income.
The trick is not to expect huge returns in a year or two. If you’re invested in a good KiwiSaver fund the snowball will start rolling slowly and speed up over time.
KiwiSaver is a long term investment and those that persevere with small regular investments in it will be amazed at the long term effect of compound interest.
I did a quick calculation for a 23-year-old earning $30,000 a year and contributing 3% of gross salary to KiwiSaver to find out what he or she might have in 2053 at age 65. I took in all sorts of variables such as 3.5% annual salary increase, 17.5% Pie tax, a 3.75% estimated return on investment above CPI, and annual inflation of 2.5%.
The grand total after all of this was $327,682.31. If he or she had started saving 10 years later at age 33, the total would only be $186,048.22, using the same figures.
Hopefully the 23-year-old would also put more of his or her salary than 3% aside for the future by buying his or her own home and building up other investments.
The moral is: he who starts young and perseveres retires more comfortably than he who starts later.
Before I move on, there is another important reason to start saving into KiwiSaver young. That’s first home deposit subsidy. After three years of saving KiwiSavers qualify for a deposit subsidy, of up to $3,000 per individual or $6,000 per couple. That rises to $5,000/$10,000 after five years. That’s a good lump sum towards a deposit.
It can be hard for some young people to imagine buying a house. The reality is that the day can come around awfully quickly – especially after meeting Mr or Miss Right. That KiwiSaver deposit subsidy could come in mighty handy. If, for whatever reason you don’t apply for the first home subsidy, you’ve still got a good chunk of savings in your KiwiSaver.
The other reason to get the savings bug young is that habits die hard. If you’re in the habit of saving early, it should stick with you for life. One of the best concepts to learn young is to save at the beginning of the month, not the end. That means planning what proportion of your income goes into savings and transferring that before you get your sticky mitts on your spending money.