Compound interest is a powerful concept in personal finance, especially for retirement planning. It’s the interest you earn on both your original investment (the principal) and the interest that has already been added to it. Over time, this can lead to exponential growth in your savings, making it an essential tool for building a retirement fund.
How Compound Interest Works
When you invest or save money, you earn interest on your initial amount. In the next period, you earn interest on the new, larger amount (your initial amount plus the interest). This process continues, and over time, the amount of interest earned grows as it compounds. on itself.
Example 1: Savings Account
– **Initial Investment:** RM10,000
– **Interest Rate:** 2.6% annually
– **Time Period:** 10 years
In the first year, you earn RM 260 in interest (2.6% of RM10,000), so your total becomes RM 10,260. In the second year, you earn 2.6% on RM 10,260 which is RM 266.76, bringing your total to RM 10,526.76. This process continues, and by the end of 10 years, your RM 10,000 investment would grow to RM 12,926.28 without any additional contributions, thanks to compound interest.
Example 2: Retirement Investment Fund
– **Initial Investment:** RM50,000
– **Interest Rate:** 7% annually
– **Additional Contribution:** RM5,000 annually
– **Time Period:** 20 years
In this case, not only does your initial RM 50,000 earn interest, but you also add RM 5,000 each year. The 7% interest compounds on the growing balance every year. After 20 years, your investment could grow to approximately RM 269,944.16, showcasing the significant impact of compound interest, especially when combined with regular contributions.
Why Compound Interest Matters for Retirement Planning
Compound interest helps your retirement savings grow faster, especially over long periods. Starting early and contributing regularly can maximize the benefits, ensuring you have a more comfortable retirement. Even though compound interest is a wonderful tool but it need 1 of very important element in order to have a meaningful or substantial accumulation of money.
Start Early to Accumulate Retirement Fund
Below is a simple illustration of every beginning of the year, we put in RM 3,600 into a investment vehicle that give us either 2.6% or 5%. As of writing, 2.6% is the FD rate of Maybank based on 1 year lock-in period. On year 10th, it only manage to accumulate total RM 41K+ after putting in RM 36,000 as the capital with accumulative of interest of RM 5,571.20. If we start accumulate for our retirement fund at age 50, do you think RM 41K+ is enough to sustain our life, maybe another 20 to 30 years?
If we start early, and let say we have 20 years before retire at age 60, then accumulation amount is RM 95k+ after putting in RM72k. And if we have 30 years, it wil become RM 164K+ after putting in RM108K. If you pay attention to the accumulative of interest earned column for 10th, 20th and 30th years, do you notice that time play an important factor for compound interest to work effectively?
