It is an amazing fact that in the entire 12 or so years we spend in school, we are rarely taught about the magic of compound interest. This simple lesson incorporated into a life skills class could have made even the most ordinary school leavers wealthy.

Interest rates are still high and anyone servicing debt has seen a dent in their wallets. However, if you are smart, you could turn high interest rates into a positive aspect of your financial plan. Making sure to keep debt under control and prioritising a solid savings plan can make you seriously wealthy.

Earning interest

Albert Einstein, not shy in the brains department, claimed that compound interest was 'the greatest mathematical discovery of all time'. But you don't need to be as intelligent as Einstein to understand the concept, and that’s the beauty of it.

Simply put, when you invest money you earn interest on your capital. The next year you earn interest on both your original capital and the interest from the first year. In the third year you earn interest on your capital and the first two years' interest. The concept of earning interest on your interest is the cornerstone of compounding.

It has a marked snowball effect because as your capital grows the interest portion gets bigger and bigger. Even a small amount can grow into a substantial sum given enough time.

Start early

The key to making interest work for you is starting early. The earlier you start investing, the more time you have for compound interest to take effect. Someone who invests R200 a month from age 20 to 29 and then lets their investments grow is likely to have more money at 60 than someone who invests R200 a month from age 30 to 59.

Over long periods of time the difference between investing at, say, 10 percent and 11 percent is enormous, so always look around for the best rates.

Don’t be discouraged if you can't save a lot: regular saving of small amounts can build up an astonishing sum of money. If you save R100 a month for 40 years and your investments compound at 12 percent a year you will have R980 000!

'Rule of 72'

A simple way to work out the benefits of compound interest is called the 'Rule of 72'. You can find out how many years it will take for your investment to double by dividing 72 by the percentage rate of growth. So it will take nine years for your investments to double if they grow at eight percent a year (72 divided by eight equals nine). But it will only take six years if your investments grow at 12 percent and so on.

The 'Rule of 72' is a only a guide line but it can give you a good idea of what to expect.

Let's look at how the smart use of interest and a good investment strategy can change your life.

The comparison

Sam and Susie met through their tears on the first day of grade one. At break Susie shared her Kit Kat, Sam shared her Gummie Bears and the friendship was sealed forever.

As they went through the trials and traumas of school together, very different personalities emerged. Sam was a saver and Susie was a spender. At 16 they both decided to get part time jobs. Every time Sam got paid, she put half of her money into her parents’ bank account and spent the rest. Susie however spent every penny.

By the time they started college Sam had saved up R2500 and Susie had perfected the art of extracting money from her parents.

They both continued to work while studying. By the time Sam graduated, she was driving a car that was paid for in cash. Susie used the somewhat unreliable public transport system.

The difference

They both landed good jobs and earned approximately the same amount of money. Their after tax income was R3000 per month. Sam continued with her savings plan, paying R700 of her income into a unit trust linked retirement annuity. Susie on the other hand realised she needed a car and borrowed the deposit from good old Dad. She took out a four-year loan and her repayment was R1685 per month.

In addition she opened up a number of accounts and indulged herself in an entire new wardrobe. As the months went by her income was all but consumed by debt repayments.

Four years down the road Sam’s investments were now worth R45 659. Susie had just finished paying off her car. Realising that she had to become more responsible with her money, Susie decided to start a savings plan.

Double the value

By this time she had an after tax income of approximately R6000 per month so she could afford to save R1000 per month. Sam could have started saving R1400 into her retirement plan but decided instead to keep it at R700 per month and start an after tax savings program of R550 per month.

By the time they were 30 (five years later) Susie's investment had grown to R88 574 (growing at 15 percent net per year) and Sam's was R158 215. The interesting thing to note is that Sam had only put in R15 600 more than Susie but her investments were worth almost double. The reason for this is that Sam's investments were growing and 'compounding' for four years longer.

When Sam decided to buy a townhouse she put down R50 000 deposit (the proceeds from her R550 per month investment plan at 18 percent net return per year) and took a loan for R110 000 over five years. Her payment was R2470 per month.

Susie, however, could only borrow R20 000 deposit from her folks and financed R140 000 over twenty years for a very similar townhouses. This is what it cost them both.

Name	Bond	Payments	Total Repayment
Samantha	R110 000	R2470 X 60	R148 200
Susie	R140 000	R2474 X 240	R593 760

Sam told Sue that she should look at paying her bond over five years instead of twenty but, at R3282 per month, Sue did not feel that she could cope. Unfortunately, this was going to cost Sue R445 560 more from her after tax income to purchase the exact same home.

When we look back upon Sam and Sue’s financial behaviour, the point of departure was really when Sam decided to save R700 toward her retirement and Sue choose to buy a new car instead.

The 'opportunity cost' of that one decision (not counting the many others we could review) could easily be measured as R445 560 extra bond payments plus R69 641 less retirement savings, equalling R515 201. We could project further and say that the head start Sam has in her retirement portfolio will translate to R2.893-million extra at age 55, but we’d rather not make Sue cry.

'Live for today'

So who would you rather be? Even if you are one of the Susies of the world, with a 'live for today' attitude, a simple decision to change your habits could make you rich.

Your first step is to admit to yourself that you are living beyond your means and squandering monthly savings opportunities that would have given you financial peace. Once you face the fact that you have a debt and spending problem, you are at the first stage of fixing it.

Our surveys show that almost everyone wants to become wealthy but almost no one thinks they can achieve it. Based on our very simple illustration, I’m sure you’ll agree that Samantha is working toward an enviable position of financial security.

Therefore, having read this article, you now know that you could (with a little extra knowledge and coaching) get on the right track and build your financial future. Or you could forget you’ve read this and keep blaming the system. Tough choice?