An Example of the Power of Compound Interest…

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Hola!

How’s it going ladies and gentlemen?

Are we all enjoying our Wednesday night!

I know, I know – there’s not too much to do on a Wednesday right.

Seems like hump day is just a prelude to “getting it over with” and waiting for TGIF.

But you know, there’s so much more to what can be achieved each passing day.

Never underestimate the power of compound interest and incremental changes!

Here, take this example I was discussing with my work colleagues today.

Now, a bit of background – we work in financial services within a fairly large institution. One might even call it a “bank”, that is one of those places where fat cats are bred.

Yet it amazes me that so few of us truly understand the simple concept of compound interest.

The best application of which I can think of is regarding our superannuation accounts.

But first a very brief background on superannuation for the uninitiated…

A superannuation account is a retirement account introduced by the Australian government decades ago to help facilitate Australians upon retirement.

This is because us Aussies – well, we’re just not that good when it comes to managing our own finances.

Hence it is mandated by law for employers to pay (currently) 9.5% of a total salary to an employee’s superannuation account.

E.g. Say Jane earns $100,000 p.a. Her employer would be required to pay $9,500 to Jane’s nominated superannuation account.

The 9.5% accumulates each year until when Jane retires. Jane can then access the monies to assist her retirement.

Note, under the majority of instances she can only access the monies once she reaches her “retirement age”. This is to prevent Jane from blowing her future at the casino – us Aussies are also degenerate gamblers as well…

The great thing about superannuation (super) is that the monies are usually invested in a myriad of investment options in funds, shares, bonds, even real estate.

It’s an enormous industry – $2.6 TRILLION in fact. Sheeeeet.

Which is why everyone wants a piece of the pie.

As you can imagine, there are some good offerings, and then there are some not so good ones.

For many of us just starting out – we have absolutely no clue what superannuation is, I mean – who cares!

Money which we can only access in 50 years? That’s not called money – that’s called frustration.

So that’s why we pick the easiest option – which just happens to be the default one our employer has.

But is it really the best one for us?

Um…no.

Because in more cases than not – the default option is tied to one of the big players in the market.

Yet their performance has been nothing short of… well, short. Here’s a graphic to sum it up:

It must be said the CBA, ANZ, NAB, Westpac have or are look… OH EM GEE – did you realise?!?! Those 4… are they not the BIG 4 BANKS?!?!

Yes that’s right – the big 4 banks have or are looking to sell their wealth management arms (for various reasons) but they are still tied in here.

Chances are – for many of us, when we started our careers with our first employer – the default option was through one of the banks because of their size, reach and marketing pull.

Annnnnd we’re paying for that now.

Now what about the best performers?

Hmmm… industry and member super funds… I…I think they’re onto something.

So what’s the difference between the best and worst performers in relation to me then?

Well…

Example: How much difference 1% extra return/year makes 

Age	25	25
Salary	$50,000 indexed at 2.5%	$50,000 indexed at 2.5%
Superannuation contribution	10% of salary	10% of salary
Superannuation earnings	7% per annum	8% per annum
Annual fees	1% of account balance	1% of account balance
Account balance at age 65	$762,162	$921,145

A difference at age 65 of $158,983.

Or in other words – difference in heading to the local YMCA for 6 free “how to tango” classes or a 6 month whirlwind tango tour of South America.

The same can be said of fees – fees, like termites – eat into your investment returns (think of them as negative compound interest).

Incidentally many of the “worst” performers, also have the highest fees.

Now, if you didn’t realize your super fund return was under-performing and want to pick a better one – there are so many free comparison websites (here and here) to help you choose.

And it’s not even that difficult to consolidate, after you’re done picking, send a couple of forms to your future super fund and hey presto! Let them take care of it.

If you want the specifics, you can’t go past the government’s Moneysmart website as to how to do it.

Higher returns and lower fees? Money for jam!

Hopefully that opened your eyes regarding the power of compound interest and a useful application of it to our daily lives.

It’s powerful because it is unseen.

So come on – what are you waiting for?

After all, what else are you going to do on a Wednesday night!

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