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How to use compound interest to grow your superannuation

Written by

Shaun McGowan

How happy would you be if someone else could do your job, but you’d still get paid? Pretty happy, right?

Well, you can’t exactly put another person to work for you – but you can put your money to work.

With compound interest, your money can make money. And you don’t have to lift a finger.

Superannuation offers an easy way to put your money to work for you with compound interest. All while saving for your future.

This isn’t to say that saving is easy – but in this case, the burden of financial growth isn’t just on you. It’s on your money too.

How does compound interest work?

In order to understand compound interest, let’s look at a simple example. Let’s say you put $1,000 in an investment fund for one year. You make five per cent interest within that year.

Now, your total in the account equals $1,050.

At this point, you have a choice. You can remove the $50 you’ve earned, or you can leave it where it is (reinvest it).

If you choose to reinvest, you’ll experience the benefits of compound interest.

You’re curious about compound interest, so you reinvest.

At a continued five per cent interest rate, at the end of year two, you’ll have $1,102.50 in that account. And that’s without adding a cent.

Imagine if you continued investing… Or if you had invested $10,000 instead of $1,000…

In that case, you’d have made $1,025 in that two-year span. All you have to do is invest your money instead of spending it, and it can go to work for you.

You can do this with virtually any investment account (although interest rates do vary), but the superannuation fund is probably the easiest way to get started in investing.

Why is superannuation such a great investment?

Can you guess the biggest danger to your investment accounts? No, it’s not a fluctuating market… It’s you.

Compound interest is an amazing thing. You can sit back and watch your money grow over time.

But there’s one catch… You absolutely have to leave your money in the account.

With superannuation, you don’t have much of a choice. You can’t access those funds until you’re ready to retire.

There’s always temptation when you see your money growing. If it’s in an account where you can access it, you probably will at some point before retirement – especially if money gets tight.

But here’s the thing. When money is tight and you’re living pay packet to pay packet compound interest is even more important to you. That is, if you ever want to retire.

How to make the most of superannuation

Okay, so we’ve established that it’s a good idea to pay attention to your superannuation account.

But if you really want to make the most of it and enjoy a financially secure retirement, there are a few things you need to do.

1. Start investing early

When you start investing is about as important as how much you invest. It’s easy to put off the investment until some future date when you’re expecting a healthier income. But what if that day doesn’t come?

And even if it does, you’ll have a lot more money by then if you start investing today.

Compound interest means that your interest is earning interest, and if you don’t have money in the game, you can’t earn interest. Think of it like a snowball. If you roll a snowball down a hill, it’ll inevitably grow. The growth seems small at first, but as it gets towards the bottom of the hill, it just gets bigger and bigger.

But you need to create that small snowball first.

If you start at 18 and invest until 65, you will have invested for 47 years. The chances are, you’ll have earned as much from compound interest as you’ve put into the fund in contributions.

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2. Add to your salary contributions

One of the best things about superannuation is that it’s automatic. As long as you have an employer and receive a pay packet, you are already investing 9.5% of your salary – whether you realise it or not. This percentage will increase to 12% within the next decade. And that only increases the opportunity for you to earn through compound interest.

But if you really want to make the most out of superannuation, consider contributing more to the fund, by making extra contributions whenever you can afford them.

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3. What If I don’t pay attention to Superannuation?

Because some of this process is automated, you might be tempted to set it on autopilot. But depending on when you started working and how much you’ve made in your lifetime, you may face the reality of outliving your retirement savings.

When you reach that point, you could be very vulnerable. It’s probably the most important time of your life to be financially secure, so you can afford any extra care you may need.

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4. How real is this concern?

Well, in the 2011-2012 year, 15 percent of people between 45 and 54 had no super. None.

How are they going to get through retirement?

We can hope they have other investments and will be fine, but this is more likely a sign that they haven’t made sound financial decisions.

Because at this point, the benefits of compound interest aren’t quite as appealing. They’re still great, but you’d have to invest a significant amount to catch up to someone who has saved since their 20s.

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Conclusion

Compound interest is the most effective and easiest way to grow your superannuation savings. And once you have your superannuation account set up, it’s a good idea to diversify your investments.

After all, compound interest also works outside of superannuation. So why not put your ordinary savings to work too, by setting up a direct transfer to an account with compounding interest and leaving it to quietly grow into a nest egg you can draw on whenever you need it?

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About the Author

Shaun McGowan from money.com.au

Shaun

McGowan

Shaun McGowan

Shaun is the founder of Money.com.au and is determined to help people pay as little as possible for financial products. Through education and building world class technology. Previously Shaun co-founded CarLoans.com.au and Lend.

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