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The beauty of compound interest

by Tom McDonald

Time in investment markets matters, especially when you reinvest interest

12 April 2019

Interest on a loan or that you receive on a deposit can be calculated in two ways: by simple interest or compound interest. How interest is calculated matters over time and that’s why financial advisers recommend paying down debt as quickly as possible and adding regularly to investments, especially very long-term investments like superannuation.

Simple interest

Simple interest is where interest is paid at maturity, for example on a term deposit. Sounds simple doesn’t it? So, if you invest $100,000 in a term deposit paying 3% per annum, and the term is 12 months, then you will earn $3,000 interest when the term deposit matures.

Compound interest

Albert Einstein supposedly called compounding the “Eighth wonder of the world”. Such is the power of compounding – it can really have a remarkable impact on the longer term returns in your portfolio.

Here is an exaggerated example to demonstrate the concept.

Which of these options would you prefer?

  1. I give you $1 on day one of the month, which doubles each day for 31 days. So on day two, is worth $2, then $4 on day three, and so on.
  2. Alternatively, I offer you $1 million right now as cash in hand?

The reality is, $1 compounding at 100% a day for 31 days turns into about $2.1 billion, far exceeding the offer of cash in hand. It is a great example of the power of compounding.

Now we are not suggesting that you, or we, can turn $1 into $2.1 billion, nor is a 100% increase daily realistic but it illustrates the point.

A more realistic example we see is when a client is disciplined and contributes the maximum concessional contribution to their superannuation limits each year, starting early and continuing up until retirement.

The Cardena investment philosophy

Our philosophy is also based on compounding and centred on three fundamental tenets;

  1. Preservation of capital
  2. Managing risk and volatility
  3. Seeking a reasonable level of return

 At Cardena we aim to generate returns that are consistent, positive returns over the medium term (three to five years). We achieve this by taking an institutional approach to investing and focusing on capital preservation, and risk and volatility, rather than simply trying to out-perform an asset sector index. 

 In practice, this leads to returns that can outperform the market over time:

Compound interest pic

For further information about how the Cardena Investment Philopsophy works in practice, please click here to view a video.

Call us on (02) 8016 3200 or contact one of the Cardena team, if we can help.


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