The power of compound interest

You’ve probably heard the adage “the earlier, the better”. While it may not have been written about superannuation, it’s a philosophy many savers live by in the pursuit of building a large nest egg for their retirement.   

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

How does compounding work? 

Compounding means 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 incremental interest injections can result in a large balance with the amount of interest you earn proportionate to how long you’re invested: the longer the investment horizon, the higher the amount of compound interest. 

The effect of compounding is perhaps best demonstrated with an illustration. Let’s say a 30-year-old gets a bonus at work and decides to put $10,000 into super. Assuming a modest 5 percent average annual return, 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, simply for being invested. 

Amount Annual Rate % Total interest Value at age 60
$10,000 3 $14,568 $24,568
$10,000 4 $23,135 $33,135
$10,000 5 $34,677 $44,677
$10,000 6 $50,226 $60,226
$10,000 7 $71,165 $81,165

Why performance matters

Of course, the amount of interest a person earns could be higher or lower depending on how their super fund performs. That’s why it’s so important to be invested with the right fund and choosing the right risk profile for your objectives. 

Active Super had a stellar year in 2020-21, reporting record returns of more than 23 percent in the Accumulation Scheme.  Over the past 10 years, the scheme’s High Growth option returned an average of 9.76 percent.* 

Even a small difference in performance can make a big difference to retirement. Let’s say that same 30-year-old again invested $10,000, but this time was earning a marginally higher 6 percent return. One percentage point doesn’t sound like much, 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 higher than the saver would achieve at 5 percent. At 7 percent, that same investor would have earned $81,165 over 30 years from their initial $10,000 investment. 

Ways to build your super savings

For those keen to bolster their balance, there are several ways to add more to super. One popular strategy is salary sacrificing, where extra contributions are deducted from your pre-tax salary. As well as adding to the super balance, the taxable income is reduced, which can mean a lower tax bill at the end of the financial year. 

As well as salary sacrificing, people can also boost their super with personal contributions from their after-tax pay. With both pre-tax and post-tax contributions, it’s important to keep an eye on the yearly contribution limits, which are $27,500 and $110,000 respectively, and eligibility rules apply. 

Contact us to find out more about strategies and objectives that suit you.

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