There’s a time-tested financial principle that doesn’t look flashy on the surface but can work quietly in the background to help you build wealth while you go about your life. Compound interest can be the unassuming and reliable friend whom people never really noticed growing up but just hung around until one day – bam! – you realise – oh, they’ve done well.
I like to think of compound interest as the introvert of the financial realm. It doesn’t strive to impress your friends, require your constant attention or try to be the ‘life of the party’.
You’ll never find compound interest boasting about how it aced the maths exam or telling you how it’s put in years to build your bank balance or the value of your portfolio. It just gets the job done.
Compound interest shows up in far more places than just savings accounts and term deposits. It applies to most investments where returns are reinvested (like superannuation, managed funds, ETFs, and reinvested dividends.)
It’s one of those rare friends that (quite literally) has your interest at heart – steady, subtle, and incredibly adept when you give it time to do its thing.
But, while it’s not a demanding companion when building wealth, it still has requirements: you have to invest something. And then, you need to give it time.
Here’s an example …
Sarah invests $100,000 into a broad Australian ETF that averages a 7% annual return. In the first year, she earns $7,000. In the second year, she earns 7% not just on her original $100,000, but also on that $7,000 – so Sarah’s return becomes $7,490.
If Sarah lets that same $100,000 sit for 20 years at 7%, it grows to almost $400,000, even if she never adds another dollar.
… That’s the quiet magic of compounding: your returns keep generating more returns, and time does the heavy lifting.
But there can be a flip side to this shape-shifting character …
The multiplier with a mean streak
Our multiplying hero does have a dark side that comes out in certain situations – like when it’s applied to different kinds of debt. And when unpaid interest is added to your balance, it starts generating more interest. (The kind you don’t want to be accruing, like the interest on a credit card or personal loan, for example.)
When you carry a balance on things like credit cards, personal loans, or buy‑now‑pay‑later arrangements, the interest isn’t just charged on what you originally borrowed – it’s also charged on the interest you didn’t pay off last month. That means the longer a balance sits there, the faster it accelerates, even if you’re not adding new spending. That’s why, if only the minimum repayments are made, a small credit‑card balance can quietly double or triple over time.
The lesson? Compound interest is a reliable friend if it’s working for you but can be a relentless collector if it’s working against you. So use it wisely.
If you need help aligning your money with your lifestyle goals, call me at Align Financial on (02) 9913 9995.
