The Eighth Wonder of the World

Apparently, it was George Bernard Shaw who quipped, “youth is wasted on the young”.  It is certainly true that life’s journey teaches us many things some of which could have been put to good use sooner, if only we had known.  Those of us lucky enough to have had mentors have been fortunate to have benefited from the wisdom of age without being old. 
The concept I am referring to is compound returns. Albert Einstein described it as the eighth wonder of the world. He went on to say “he who understands it, earns it ... he who doesn't ... pays it. Compound interest is the most powerful force in the universe.”

This column is based on an article that a mentor gave to me almost 30 years ago. That experience taught me that a single concept, delivered at a “teachable moment”, can change a life - if not yours, then someone else’s.

For many people the barrier to learning and applying this knowledge is that it is mathematically based and not at all intuitive so our brain tends to reject it. So let’s use an example that you can check with your calculator.

Imagine you are 21 again.  You decide, because someone explained compounding interest to you, to start a savings program with $5,000 and then add to it at the rate of $1,000 a year – until you turn 30.  You then stop saving altogether and leave your nest egg alone until you turn 65.  Let’s say, for the sake of this comparative exercise, that you earn an average return of 7% p.a.* (after fees and taxes) which you always reinvest.  Let’s say, again for the sake of the comparison, that inflation is 0% (so your real return is 7%).

Now imagine an alternative scenario.  Again, you are 21 but decide to do nothing about saving until you turn 31.  At 31, you put aside $5,000 – adding to it at the rate of $1,000 until you turn 65, again reinvesting the 7% p.a. average return.  You figure you will more than make up for lost time by saving harder – i.e. for 35 years rather than 10 years.

Which is the better strategy?

The 10-year saving plan, in which you will have invested $14,000 (a $5,000 initial contribution then $1,000 a year for nine years) will reap $226,026.  The 35-year plan, in which you will have invested $39,000 – nearly three times as much – will reap considerably less: $178,149.

Here are the basic calculations for you to check.  The blue type represents those years when you contribute.  The return, remember, is a constant 7% p.a.*

Age	Savings  Start  at  21	Savings Start at 31
21	$5,000
25	$10,994
30	$21,170
31	$22,652	$5,000
35	$29,692	$10,994
40	$41,645	$21,170
45	$58,409	$35,443
50	$81,922	$55,462
55	$114,900	$83,539
60	$161,154	$122,918
65	$226,026	$178,149

*The return figure of 7% pa is slightly below the average return (after fees and taxes) reported by all Growth KiwiSaver Funds over the last 5 years.

The table shows the dramatic effect that compound interest can have on a disciplined savings plan, even when you stop saving.

KiwiSaver has been a game changer by helping people see the benefits that time and compounding returns can deliver. However, the benefits of compounding returns are not just limited to KiwiSaver.


Compounding returns work at any level but their greatest “magic” will normally be delivered by a diversified strategy that has been designed with your needs and temperament in mind, in other words,  as part of a plan.


I suspect that not too many 21 year- olds read this column but if you are a parent, or grandparent, perhaps you should cut this out and stick it to the fridge, or for those more technically savvy, add it to your Facebook feed.

But, as I have said before; knowledge is nothing, execution is everything.

Peter Ashworth is a Principal of NZ Funds Management and an Authorised Financial Adviser based in Dunedin. The opinions expressed in this column are his own and not necessarily that of his employer. His disclosure statements are available on request and free of charge.

First Published in the Otago Daily Times in August 2017